Gusts of honour

The idea that you should seek stable, predictable income by relying on wind – perhaps the most variable of all climatic elements – sounds like a questionable one.

And yet that's precisely what a growing number of long-term investors have lately been doing. According to  Infrastructure Investor Assets  , 350 wind deals, worth about $46 billion, were closed globally over the last couple of years – over a quarter more than the three previous years combined. And that's small fare compared with the dry powder institutions have now earmarked for the sector.

Onshore wind, in particular, is seeing no clouds on the horizon. “You have ample funding available at most stages of the life cycle of a project,” says Mark Dooley, head of infrastructure, utilities and renewables at Macquarie Capital Europe. “And when you get to operational assets, the pool of capital looking to be deployed is very, very deep.”

A combination of factors account for this gust of interest. Tom Snow, head of institutional and strategic relationships at Sydney-based fund manager Whitehelm Capital, explain that the sector offers “proper long-term, infrastructure-like returns” – arising from the ability, across much of the developed world, to lock in long-term revenues through power purchase agreements (PPAs) or public support mechanisms.

In addition, says Joost Bergsma, a founding partner and chief executive of London-based clean energy fund manager Glennmont Partners, “there is a lot of experience of how wind turbines perform in real life”. Great progress has also been made in forecasting how wind blows – thanks to a method he calls Measure Correlate Predict, which takes the raw climatic data for a site, correlates it with sites nearby and predicts wind speed over time.

“Because with wind there is now such a large installed base, the forecasting exercise is often very robust.”

It helps that the technology has grown both more mature and sophisticated, with turbines now able to operate well at lower wind speeds. Such advances, added to the scaling up of equipment makers, has allowed production costs to dramatically come down, notes Susanne Wermter, who heads the specialist investment team of German-based investment manager Aquila Capital.

FLAGGING RETURNS

But onshore wind may be on the verge of becoming a victim of its own success. “It is now much harder to find value,” says Dooley.

The stable, predictable cash flows onshore wind has proved able to generate has attracted a number of new players to the market, as a result of which assets of all sizes are being keenly bid for. Yieldcos – publicly traded companies that own a portfolio of projects and distribute the cash flows produced to shareholders – have now become a force to be reckoned with, says John Barry, a managing director within the energy infrastructure team of US fund manager First Reserve.

Dooley distinguishes between European vehicles such as Greencoat UK Wind, which tend to seek growth through bolt-on acquisitions and a stable yield of 6 to 7 percent, and US ones, which take on projects earlier in the development stage and grow yield over time. The former follow the same methodology as their public-private partnership listed cousins, while the latter are often side-car funds spun off from big American developers.

Yieldcos now regularly crop up at the smaller end of the deal scale, bidding during auctions involving up to two or three wind farms, observes Chris Tanner, investment adviser to the London-listed John Laing Environmental Fund.

Meanwhile he reckons big portfolios of assets are a favoured target of large institutional investors, which tend to take the direct investment route. “Some of these deals are structured as sales of substantial stakes. The original owner maintains a part in the portfolio and typically does the asset management after completion of the transaction.” And while the biggest investors have enough firepower to target 200 megawatt-portfolios, they generally don't rule out 20-megawatt assets either.

The resulting increase in competition is having obvious consequences. “Because of their steady revenue and cost structure, operational wind assets sell for single-digit returns to long-term hold yield investors,” says Peter Rossbach, head of private equity at London-listed fund manager Impax Asset Management. Other fund managers reckon expected performance, over the last few years, has fallen a couple of points to between 6 and 8 percent.

CLIMATE CHANGE

Some investors point to a shift in attitudes at a higher level. “In a lot of countries, there is a feeling that tariff support for the sector is coming to the end of its political life,” says John Breckenridge, a managing director within the clean energy and infrastructure team of Swiss-based fund manager Capital Dynamics.

The picture varies greatly across markets. In Europe, countries including France and Germany continue to back the industry through stable feed-in tariffs. But in a number of other markets, the tide is turning towards auction-based systems involving a greater degree of market exposure. That is the case in the UK, which is shifting from the Renewables Obligation regime to Contracts for Difference; Italy recently took the plunge too.

Yet others move in the opposite direction: Finland recently revamped its tax regime to boost small-scale renewables facilities. Ireland is also singled out as offering an attractive regime, both inflation-linked and close to market price.

Meanwhile issues remain to be solved in the US, where tax incentive policies, which can only be extended on a one or two-year basis, creates unnecessary uncertainty. “For now there is a nice tail end of projects in development but later in the year the market is likely to slow down,” Breckenridge says.

Others see the move away from overly secure and generous support regimes as a natural one. “Renewables have already made significant progress towards reaching grid parity. We are hoping that the competiveness of renewables will continue to get better so that governmental support for new capacity will become unnecessary,” says Wermter.

Dooley reckons the shift to auction-based systems will further boost efficiency, while Bergsma believes political drive behind renewables has never really been in question. “Most politicians left, right and center continue to be supportive of renewables. What they say in the press and what they actually do can be quite different.”

BRIGHTER HORIZONS

Neither does the fall in oil prices, and its potential implications for renewables appetite, seem to be a major concern for investors. “Oil is mostly used as a transportation and industrial input rather than a part of the electricity generation base,” says Rossbach. Any impact will be partly mitigated by a further fall in wind energy input costs over the past year, reckons Barry.

Turmoil in the oil markets may actually be channeling even more money towards renewables ventures, as disgruntled investors previously targeting upstream and midstream assets turn to what they see as safer opportunities.

In this context, safeguarding returns is increasingly requiring fund managers to adapt their approach. Dooley say some managers are moving “earlier and earlier” in the development cycle to try and find value. “Two years ago few people were prepared to invest during the construction phase. Now it is clearly starting to happen.”

Fund managers can mitigate risks by partnering with developers. Those which have long been used to taking a degree of development risk, such as Impax, Glennmont or Capital Dynamics, say they still post similar IRRs as they did a few years ago. Generally made with a view to reselling the asset as part of a portfolio after a few years of running it, these investments can generate mid-teen returns, says Breckenridge.

Not everybody is keen to take on development risk, however. Snow explains that Whitehelm would typically invest in wind farms only with the hindsight of two or three years of operational data. But the firm is also turning its sights to developing markets: in addition to a Swedish deal closed before Christmas, the firm's renewable investments have included a wind farm in Taiwan and solar projects in Peru.

The strategy is not devoid of pitfalls. Snow says robust PPAs are much harder to obtain in emerging markets, and that because of the number and nature of stakeholders generally involved, investment processes can take more than a year. As Barry underlines, however, successful wind ventures in developing countries like Mexico have a clear advantage: they compete on an equal footing with other power generation sources.

Investors of sufficient size are also considering offshore wind ventures. Typically involving very big equity tickets – up to several billions in some cases – the sub-sector is no doubt emerging as an investable asset class, Breckenridge asserts: “Governments are being very clear about the upcoming pipeline, and remain unambiguous in their support. Production costs challenges, meanwhile, will sooner or later get sorted. I thus believe offshore wind is promised a very strong future.”