Thoughts on the first half of 2022, and outlook for the next six months
As at the close of May, the NAV per share of the Premier Miton Global Renewables Trust (“PMGR”) finds itself at roughly the same level as at the start of the year. While this is slightly disappointing, it represents a reasonable outperformance when compared to global equity markets.
Market sentiment is dominated by high and rising inflation, concerns regarding how high interest rates will go to bring it back into line, and how to deal with two of the fundamental inflation drivers, energy and food prices. The demand for both of these is relatively price inelastic, and as a consequence, consumers can reasonably be expected to restrict expenditure on less essential items. The war in Ukraine looks likely to drag on for some time, and as such, I expect it may also take some time for energy prices to fall back to previous levels.
The debate surrounding renewables, for so long centred on environmental issues, has pivoted toward security of supply, and in our opinion, this bodes well for future growth (as the “lights going out” in the next couple of years is a more pressing concern for most politicians than future climate change). This is particularly the case in Europe as the EU seeks to find ways to wean itself off Russian gas imports. The British government has stated a desire to see construction of more large-scale nuclear plants, but the recently announced further delay and additional cost over-run at Hinkley Point C illustrates that this is a high risk and very costly option.
Renewable energy, in the main having very low marginal costs, tends to be a “price-taker” in power markets, which remain dominated by fossil-fuelled generation. Higher gas and coal prices have fed into higher electricity prices. Renewable generators are therefore in the advantageous position of seeing higher revenues, while not experiencing the underlying cost pressures from higher fuel prices.
In some countries, politicians looking for ways to mitigate higher energy tariffs suffered by consumers, have resorted to “windfall” taxes. Such measures have been implemented in Spain and Italy for instance, and there are now rumours that the UK renewable sector may also be hit with a special tax. This seems rather counter-intuitive to my mind, in that the renewable industry is not responsible for the increase in electricity prices, and the government is counting on the industry to fund the billions in investments required to transform the UK energy system from one dominated by fossil fuels to one based on clean renewable energy. While it may make for good politics in the short term, in the long term it will increase those companies’ cost of capital and could lead to a reduction in UK investment levels as they re-direct investment to lower-risk jurisdictions.
In terms of what has been helping, and what has been hurting performance so far this year, I would summarise the position as follows:
UK and European renewable generators
Despite recent weakness from the threat of windfall taxes, UK renewable generators have had a positive start to the year. They are selling power into a market that is under-supplied, and heavily influenced by gas prices, which has been beneficial for holdings such as Drax and Greencoat UK Wind. European generators such as RWE and Iberdrola have also benefitted from strong power pricing.
Global renewable developers
Renewables are increasingly seen as global growth companies. Companies such as Acciona, Grenergy, and Solaria are utilising the expertise gained in their home markets (in their case Spain) to expand internationally. They have developed sizable pipelines of future development projects that will be difficult for new entrants (such as oil and gas companies) to replicate in our view. They have been able to access new equity funding, which together with attractively priced bond and bank financing, could allow for strong growth over coming years.
UK battery storage
The expansion of the UK renewable sector has forced the National Grid system operator to spend more on grid balancing and frequency regulation. Battery storage projects have been successful in capturing a sizable portion of this market, and have seen their asset values increase as a result.
The portfolio retains a material weighting to China despite the very negative investment sentiment surrounding the country. Share prices have fallen so far in 2022 as foreign investors have repatriated their investments closer to home. However, renewable energy generation remains on a growth path and I expect this to continue. Historic analysis shows a close correlation between generation volume and company earnings, so I remain positive on future prospects for the portfolio’s Chinese holdings.
North American renewable generators
North American renewable generators tend to sell their power on long-term contracts, with relatively fixed, pre-determined, pricing. Market exposures are low. This means that their earnings profile, while fundamentally low risk, may be subject to value erosion from higher inflation. Along the same lines, higher interest rates mean that future earnings have a lower present value when discounted at prevailing interest rates. I had to an extent, anticipated this, progressively reducing US exposure during 2021 and reinvesting in Europe and the UK. However, the remaining positions have been an area of under-performance so far in 2022.
While the portfolio had no direct Russian investments at the time of Russia’s invasion of Ukraine, it held Finnish nuclear and hydro company Fortum, which had substantial Russian exposures, both directly, and through its German based subsidiary, Uniper. I was disappointed by the company’s reaction to the situation, which amounted to little more than a wait and see approach. The holding was therefore sold, resulting in a sizable loss compared to its valuation at the start of the year.