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The ‘post-subsidy era’ is as much a marker of the success of renewable energy ambitions as it is of the changing times and a shift in the opportunity for investors.
As the cost of developing renewable power projects and the surrounding infrastructure required has fallen, so too has the need for governments to continue to prop up the sector. The removal of subsidies in recent years, largely in Europe where they were embraced as a popular policy-ploy, marks a clear change in direction, and highlights a stark challenge for investors.
This new era requires a shift in mindset and a different approach to scouting out opportunities, but there are fears it is a mindset that a significant proportion have failed to adopt. There is an inherent danger in investing in a sector without considering that subsidies may be withdrawn, and yet this is a risk that many ‘clean’ investment vehicles seem to be ignoring.
The early years
In the early years of the energy industry revolution, when pressures to address the grim realities of carbon emissions and the impact on our climate became too much to ignore, subsidies were a welcome and necessary tool favoured by governments to kick-start key projects. Investors were able to provide capital to a range of new technologies while benefiting from government support, which has been wide and varied. Government strategies have ranged from offering direct support in the form of price support mechanisms and carbon credits, to more gentle encouragement of private capital involvement and an offer of tax breaks. In the years that have followed the initial boom in activity, however, we have witnessed how this support can quickly be taken away and the risks investors face if they relied upon subsidies to support underlying assets.
Generous subsidies do remain in place today. While the UK has largely ended the practice, to further its goal of sparking a ‘green industrial revolution’ the government has recently backtracked and will subsidise some renewable projects in onshore wind and solar panels for the first time since 2015. However, the experience across Europe in recent years has pressed home the dangers of relying on subsidies as part of a long-term investment portfolio.
As a result, the likes of Power Purchase Agreements (PPAs) have seen a surge in popularity. However, as the pool of subsidies shrinks, the number of investors competing to secure access to PPAs has grown. Today, it is a competitive space and the risk of returns being compromised as a result is high. Again, it is an area that investors should be careful about when constructing their portfolios.
As the renewable energy sector continues its shift away from subsidies and the PPA space grows ever more crowded, investors should look for a third way to scout out strong opportunities offering stable, long-term returns.
In addition to focusing on areas where government support ensures high returns in the short term, investors should also be trying to capture strategic opportunities, and uncover underlying structural issues that can be solved by private input alone. This is an area of great opportunity for private capital, and one that can have a far more lasting and positive impact.
One example of facilitating private action to have a real impact in an area with a structural need for investment in renewable energy can be found in Brazil and its distributed power networks. Here, net metering policies allow end users to sponsor small renewable generators to get a discount in their energy bills – a policy that encourages action on clean energy without direct subsidy or government funding whilst addressing the need for local power generators.
Building a portfolio with exposures to what we term ‘post subsidy world’ is crucial in the renewable energy sector, and while it can be achieved by focusing on key underlying imbalances unlikely to be affected by government policy, it can also be achieved by seeking to focus investment on a global scale, rather than regional. Diversifying investments across a range of different regions can help limit the impact a policy change in one area has on a portfolio.
Importantly, investors should not become complacent. Depending on subsidies and other types of government support to ensure the success of an asset is not a sustainable long-term solution for private investors who must avoid being at the mercy of policy changes and government whims.
There is a great ‘policy risk’ inherent in an issue such as renewable power generation, which has serious implications not just for the environment, but also on the economic fortunes of a country and the political fortunes of its leaders – investors should minimise this as far as is practical.
The post-subsidy era marks the closing of one door into the renewable energy market, but also the opening of a window of opportunity for investors. Net Zero ambitions still need to be met and the next decade is likely to be shaped by private capital in the global quest to transition away from fossil fuels and towards a more sustainable energy future. It is the job of investors to find a place in this energy transition to provide the crucial capital that will be needed not just today and tomorrow, but in the years and decades ahead.
Eduardo Monteiro is co-Chief Investment Officer at Victory Hill Capital Group