Renewable Sector Focus Q2 2016

Renewable Sector Focus Q2 2016

Following the Paris climate conference (COP21) in December 2015, 195 countries adopted the first-ever universal, legally binding global climate deal, due to come into force in 2020 and designed to avoid damaging climate change, with the aim of keeping long-term global warming below 2 degrees Celsius. This global action plan commits governments to the almost entire replacement of fossil fuels by cleaner energy in the second half of this century.

In conjunction with the proposals outlined, institutions such as the World Bank announced plans to aid developing countries in fulfilling their COP21 pledges by supporting the addition of significant new capacity, with up to $29 billion of fresh renewables financing annually by 2020.  Whilst this is creating further momentum for the renewables sector, by no means is the industry dependent on these grand plans for validation of the renewables investment case, having experienced many years of sharply rising capital investment – it is estimated that global investment in the renewables sector has been around $2.3 trillion since 2004.

This dramatic increase in the size of the industry and recent technological innovations are now helping to drive down generation costs, allaying long-standing concerns that many projects are too dependent on government subsidies to be economical. In fact, a recent Bloomberg report cited solar and wind auctions in Mexico and Morocco that ended with winning bids from companies that promised to produce electricity at the cheapest rate, from any source, anywhere in the world. 

According to a recent UN-commissioned report, 2015 saw further investment into the Renewables sector. The key findings of this report were $285.6 billion of fresh capital committed to renewables (excluding large hydro-electric projects) – a figure that includes early-stage technology and research and development as well as spending on new capacity. This equates to a 5% gain from 2014’s figure and exceeded the previous annual record ($278.5 billion) achieved in 2011. Other notable milestones included new allocations to renewables investment outstripping that of coal and gas-fired generation by a ratio of around 2:1 last year.

Additionally, developing world investments in renewables topped those of developed nations for the first time in 2015, with the developing world (including China, India and Brazil) committing $156 billion (up 14% on 2014) versus the $130 billion (down 8%) committed by developed countries. As in previous years, the report shows the 2015 renewable energy market was dominated by solar photovoltaics and wind, which together added 118GW in generating capacity, far above the previous record of 94GW set in 2014. Wind added 62GW and photovoltaics 56GW. More modest amounts were provided by biomass and waste-to-power, geothermal, solar thermal and small hydro.

Despite the overwhelmingly positive news-flow coming from the sector, there have been a number of cautionary tales of late. SunEdison, formerly one of the largest renewable energy development companies in the world, has just become the largest US bankruptcy of the year, listing $16.1 billion of debt and $20.71 billion of assets. At its peak the company was valued at around $10 billion. The company used low-cost capital to expand rapidly and then employed financial engineering to hive off some of its completed projects into so called yieldcos, which offered their cash flows to income-starved investors, while the company secured cash for further projects/acquisitions without losing control over the projects held within the yieldcos. The acquisition-led strategy then began to stall as investors balked at some of the later deals and financing dried up. Cash flows could not cover debt repayments and the company subsequently applied for bankruptcy protection.    

The intermittent nature of power generated by renewable energy is also something that has yet to be fully overcome. Large gluts resulting from ideal conditions force conventional generation to shut down (most of which is designed to operate continuously), putting further pressure on their continuing viability. At the other extreme, abnormal weather conditions can also cause problems, especially if there is an over-reliance on one particular form of renewable energy. For example, Venezuela is facing a major drought, which has dramatically reduced water levels at its main hydroelectric dam. As a result, the government has imposed a two-day working week for public sector workers as a temporary measure to help it overcome this energy crisis.

Most countries have invested in a diverse renewable energy mix to avoid these issues however. In 2015, more attention was drawn to battery storage as one way of providing fast-responding balancing to the grid, whether to deal with demand spikes or variable renewable power generation from wind and solar. As alluded to earlier, ‘lumpy’ electricity supply and a lack of innovation in electricity storage technology to deal with this issue has been one of the main limiting factors in renewables becoming a primary source of energy generation. However, new innovations, especially battery technology in the electric car industry are helping to bridge this gap.

Despite all these impressive figures, renewable energy only accounted for around 10% of global electricity generation last year, with the existing stock of conventional generation capacity continuing to dominate. This demonstrates the continuing compelling growth story for the industry, with the added caveat that finding attractive investments in this sector remains challenging, with few companies finding the right business model for sustainable growth, in what is still a relatively fledgling industry.

Hedge Fund sector insight Q2 2016

Hedge Fund sector insight Q2 2016

Global commodity focus Q2 2016

Global commodity focus Q2 2016