Funds for renewable energy are torn between a ROC and a difficult situation

According to James Mackreides, renewable energy funds are solely to blame for their inability to gain investors' trust, despite being severely impacted by the government's consultation on changes to subsidies

The renewable energy industry in the UK is struggling. The government began holding a consultation at the end of October to modify the Renewables Obligation Certificate (ROC) program, which provides some subsidies for the production of renewable energy. The retail price index (RPI), which is currently used to link subsidies to inflation, may now be replaced with the consumer price index (CPI). Subsidies would increase more slowly in the future because RPI typically rises faster than CPI (the difference varies, but one percentage point is a general rule of thumb).

For this, the government has put forth two options. In 2026, one is to convert to CPI. The alternative is to backdate the change to 2002, the year ROCs were first introduced, by freezing the current price until a new "shadow price" linked to CPI since 2002 catches up with the current RPI-linked price, at which point it will increase with CPI. Both options are bad, but the latter is obviously worse. As a result, shares of listed renewable energy investment funds (REIFs), which had already suffered a number of setbacks and issues in recent years, fell even more.

The ROC schemes closed to the majority of new applications in 2017, so the changes would not directly affect new investments. However, the changes will have an impact on the profits of existing wind and solar farms, as they have been promised subsidy payments until 2037 in some cases. More generally, the presumptions that underpin current investments are compromised by making retroactive adjustments. Investor confidence in making future capital commitments will be damaged by that.

The shift from indexing on RPI to using CPI is likely to result in a slight decrease in the average household bill, even though the subsidies are ultimately paid by users as part of their energy bill. Infrastructure funds contend that it will ultimately be counterproductive because it will likely increase the cost of capital for upcoming projects. The government's Clean Power 2030 (CP30) plan, which calls for £40 billion in private investment annually in green energy between now and 2030, is undoubtedly overly optimistic.

I'm growing impatient with funds for renewable energy.

Depending on which option is selected and how much ROCs contribute to their incometypically between 40 and 50 percentthe change will have a direct effect on listed REIFs. This could be the last straw for many investors and more proof that the industry is dysfunctional and unlucky. Although the government is undoubtedly to blame for this specific shock, investors have not been encouraged to give the REIF sector the benefit of the doubt due to the way it has evolved in recent years. Although I'll mostly concentrate on solar funds here, it's impossible to treat all REIFs in the same way, and many of the issues are more general.

According to statements released by Bluefield Solar Income Fund (LSE: BSIF), Foresight Solar Fund (LSE: FSFL), and NextEnergy Solar Fund (LSE: NESF), the impact on net asset value (NAV) would be approximately 2%, 1.6%, and 2% under option one, and 10%, 10.2%, and 9% under option two. I think this is doable. But first, we ask how much investors believe these reported NAVs, which are predicated on "mark to model" and fair value accounting. Some skepticism regarding these valuations is implied by the fact that the majority of REIFs trade on 3040% discounts to NAV, and the fact that dividend yields are between 10% and 15% raises questions about their sustainability.

The REIF model's original flaw is that it was based on the ability to regularly issue shares at premiums to NAV in order to finance new initiatives. During the economic, social, and governance (ESG) boom, REIFs were promoted as a growing income story in a low-yield world with an added bonus of a green angle. However, they were constantly taking money in with one hand and paying it out with the other; as a result, NESF's outstanding shares have doubled from 278 million to 555 million ten years ago. The REIFs no longer have access to inexpensive equity because this model only functioned when the shares traded at a premium to NAV. Also, debt is no longer inexpensive. Reducing dividends and reinvesting the money might make sense, but it would turn off investors who made income-driven purchases.

This explains their growth issue, but even as a limited-life income asset, many investors are wary of them due to the opaqueness of returns. The NAV is, in theory, the present value of anticipated future cash flows. Because of this and the emphasis on paying consistent dividends, REIFs appear to have very straightforward, predictable economics. The real world is more nuanced. Forecasts of power prices from outside forecasters are the basis for projected revenues. NAVs alter as these do. In the meantime, there are many practical issues with actual performance.

There is the quantity of sunlight that strikes the solar panels. The question is whether all of it is utilized or if grid outages result in some being wasted (FSFL's UK production was 8.9% over budget in the first half, but it would have been 13% higher without outages). A surplus of solar energy will occasionally flood the system on sunny summer days, setting the marginal price (at extremes, the unsubsidized price may even go negative). Because of this, the "capture price" that solar farms receive can occasionally be lower than the base load price, which is the cost of consistent, continuous power. This summer, capture rates have regularly fallen to 80%. Additionally, producers may be curtailed (turned off) by the system operator, resulting in lost revenue, if the grid is physically unable to handle the power being supplied.

The managers of REIFs use power purchase agreements (PPAs) to set prices for a large portion of their output ahead of time because stability is a top priority for both lenders and shareholders. However, this means that they don't profit much from increases in spot prices (caused by rising gas prices, which typically determine the marginal UK power price). A confusing set of presumptions results from the combination of all these elements. For instance, from 139 per megawatt hour (MWh) in September 2022 to 61/MWh in September 2025, NESF's short-term power price assumptions have decreased by 56%. Over the same three years, the longer-term power price assumption increased by 22%. However, since it floated in 2014, its 20-year average price forecast has been cut in half, indicating long-term downward pressure.

Can funds for renewable energy reassure apprehensive investors?

It is unclear whether management is attempting to conceal bad economics through financial engineering, unconsolidated statements, fair value accounting, and unverified assumptions. What is the outcome of attempting to condense such complexity into a single NAV that is always changing? Although the accounting is opaque and difficult to compare across funds, it may be accurate in theory. Skepticism increases each time NAVs are downgraded and forecasts turn out to be overly optimistic. The REIFs currently trade at significant discounts to NAV because of this. Another factor could be policy risk, as evidenced by the government's proposed change to the ROC. I).

The majority of REIFs don't seem to know how to win over investors' trust. Share buyback programs have been used to try to address the NAV discount, but they haven't been able to stop the selling wave. Additionally, buybacks frequently result in higher leverage. In May of this year, NESF had to halt its buyback because it would have exceeded the policy's 50 percent debt-to-gross asset value limit. The exact thing that anxious investors do not want to see is rising debt.

Many have attempted to sell assets in order to raise money for buybacks and debt repayment, as well as to validate NAV using actual selling prices. The slow pace of this process indicates that it might be challenging to reach prices that are reasonably close to NAV. For instance, NESF announced in April 2023 that it would sell 246MW of subsidy-free solar capacity in the UK through five different projects. Two projects totaling 100MW have yet to be sold. The sale of FSFL's Australian portfolio (170MW spread across four sites) was announced last year, but it has since been put on hold. There were a few bids for the portfolio, but none of them were judged deliverable. It set aside an additional 75MW for sale in March of this year, but thus far there have been no results.

In order to concentrate on creating a 1.4GW pipeline of projects, Bluefield recently suggested merging with its manager. However, shareholders swiftly rejected that model, which suggested a dividend cut (it is not surprising given the sector's record if they were skeptical about the potential returns on capital). The fund had no choice but to abandon this and sell itself. With a yield of 13% and a discount to NAV of 39%, the share price has dropped to new lows below 70p, and this hasn't stopped it.

Despite these difficulties, REIFs that have faced continuation votes have generally prevailed thus far, most likely due to investors' doubts about their ability to sell their assets, repay the debt, and provide a respectable return for shareholders. As investors grow more nervous, this detente might be shifting. Since the chairs of NESF, FSFL, and BSIF have all resigned in the last year, it may be time for new brooms to take over.

As appears to have happened with battery funds, we may be approaching the peak of pessimism. I purchased a position in NESF based on the possibility that the dividend would be reduced, but a lot of the negative information was already reflected in the price, with a yield in the midteens. However, it would be much simpler for investors to determine whether they still wish to support these "sustainable" investments if the REIFs accounts made it clear how much cash is generated per pound invested per MW and whether it is declining.