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To invest mostly in operating UK wind farms with the aim to provide investors with an annual dividend that increases in line with RPI inflation while preserving the capital value of its investment portfolio.
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The NAV (as calculated and quoted by UKW and similar companies) is based on a discounted cash flow analysis over the life time of the assets. Unless I'm mistaken, depreciation doesn't come into it, as that's not a cash flow. The NAV calculation makes some assumption about the life of the turbines. If that assumption turns out to have been too high, then the will NAV have been overestimated. If I've understood correctly, the NAV does not consider possible replacement of the turbines at the end of their lives. It is the NAV of existing assets, not potential future assets.
If we forget about the NAV and just consider the sustainability of the dividend, then the dividend needs to be covered with enough surplus left over to pay for replacement of the assets. I think I once calculated (very roughly) that they needed a dividend coverage of 1.2x just to pay for replacement, assuming no real terms increase in the replacement costs, and I think I assumed a life time of 30 years. That first 0.2x surplus over dividend coverage (or whatever the correct figure is) should IMO be considered a kind of maintenance capex, and not a true surplus.
If replacing the assets turns out to be not economical, they could instead pay out surpluses as an extra dividend, which shareholders could reinvest in something else to make up for the eventual loss of dividend income from UKW.
I don't think it would be appropriate to say that UKW doesn't need to pay for asset replacement out of earnings, on the basis that it could instead rely on new equity raises to pay for asset replacement. If it did that, it would be expecting new shareholders to subsidise existing shareholders, and why would they do that?
Hi Actuary thanks for your reply that's useful thanks. I'm thinking i was confusing myself earlier on the re investment in relation to depreciation wear and tear. However i think i had my numbers wrong, looks like (surplus profit as % of NAV after dividends being paid) 1% in 2020 (too low) 4% in 2021 (fine) and 10% (very high) in 2022
if i have these second figures right the reinvestment should cover the depreciation. 2022 in fact was a fantastic profit result and investment figure -- although we know we cant expect that every year...
i'm thinking a good diversifier for the portfolio and yields higher than BP..
Hello dadean,
The depreciation of existing wind farms is offset by the reinvestment of retained profits in new wind farms. This is why UKW believes its NAV per share will grow broadly in line with inflation. On this basis, I would estimate the long-term return on UKW shares as 6% per annum above the rate of inflation (whatever that turns out to be).
Hi, i bought into this as been watching it for a year or so, i do wonder if we are eating our own tale when it comes to NAV.... scant few details on depreciation in the accounts, if a wind farm has a life of 25 years crudely we could expect 4% depreciation on the asset anually... when looking at the accounts i could infer 1% from the investment managers report.. which would suggest underfunding organically paid reinvestment..... which could mean that the existing assets eventually get to the end of their life with underfunding organic replacements.... (additions aside) could this be the case? or do we think NAV will be maintained?
I also looked at the accounts of a private windfarm business -- community wind farm ltd, and jeez they are bags more profitable than this albeit a smaller firm...... im quite happy with my 6% div, but so long as we are not getting it at expence of a 2% NAV Burn which is under reported
Why the rise? I think that's just because the market has fallen so quickly that it's due for at least a short snap back!
Perhaps we should have a 'Why the rise' thread today - the 'alt 'trusts are leading the FTSE 250 , many with 4-5 % gains.
Hi Tichtich.
"Too many of those new windfarms appear to be planned on Nimby land"
As below, I'm pretty sure they'll sort out the strike price problem with lobbying, and the next government if Labour have already openly supported a vast amount of projects and subsidy so should be fine.
My only concern is when the wider market drops, we drop faster, and our dividend hikes must keep pace with inflation, which as we all know is easier said than done.
Next dividend is in August. Chart did show a cycle between last few dividends which is why I recently went top heavy in the mid 140s, looking to trade my holding larger. We''ll see.
Agree tichtich,
Wind energy is now too big a part of energy generation to be replaced. Electricity prices are main source of risk (rather than running costs or even wind resource). Hopefully, the gradual shift to electric cars will be beneficial for the industry.
One way to reduce costs would be for the government to stop blocking new onshore wind farms.
Personally, I'm not so concerned about the rising cost of new wind farms, as long as UKW's existing wind farms continue performing well. In fact, a barrier to building new wind farms could help reduce competition for existing ones. I'd be quite happy if UKW stopped raising new equity for expansion.
If I'm going to worry, I'll worry about the electricity prices that UKW will be able to earn over the longer term.
Hi Actuary. I see, is that not part of the blunt mallet argument ?
Or simply to do with narrowing margins, electricity price vs costs (interest rates/staff/materials etc etc).
I seem to have opened a can of google worms, as more and more are crying out for new government rules to allow strike price flexibility.
https://dailybusinessgroup.co.uk/2023/03/offshore-wind-farm-at-risk-without-tax-breaks/
Which highlights that certain wind farms have no chance of being built without more subsidies.
https://www.pv-tech.org/how-will-the-uk-cfd-scheme-fare-against-the-rising-cost-of-capital/
And the same including other renewables like solar, on similar schemes.
Interesting twitter thread which though favouring one side of an argument is posting some interesting links.
https://twitter.com/LoftusSteve/status/1669760302672478233
The point I was making is that similar price falls (over the past 6 weeks) have occured outside the renewables sector, which suggests the cause is not particular to the renewables sector.
Https://watt-logic.com/2023/06/14/wind-farm-costs/
Another article arguing that a change in strike price rules is needed.
IMO This is the kind of thing that sends a blunt mallet to a whole sector regardless of the details of how individual companies business is actually going.
----
Time to accept that wind farm costs are not falling
Falling subsidy prices at the same time as massive manufacturing losses makes no sense and is clearly not sustainable. Of all of the projects that secured Contracts for Difference (“CfD”) agreements in the most recent subsidy round, known as AR4, only two have actually taken their Final Investment Decision (“FID”) – ScottishPower’s East Anglia 3 project, and Moray West which is a joint venture between EDP Renewables and ENGIE. Ørsted has warned that Hornsea 3 could be at risk without Government action “to maintain the attractiveness of the investment environment”. It has said it will make its final investment decision later this year.
The Government has said that the CfD is structured to take inflation into account, but other than introducing 100% capital allowances for a limited period in a bid to stimulate business investments in the Spring Budget, it has offered little additional help to renewable developers. “Long-life assets” only benefit from 50% relief, with many commentators believing that wind turbines will be considered to be “long-life assets” – these are typically assets with a life of at least 25 years, which tends to be the upper limit of the life of a wind turbine.
With the pot of money available for AR5 being lower than for AR4 there are now real questions about the sustainability of the trend of ever lower strike prices, and whether the AR4 projects will ever see the light of day.
Senior participants at last year’s WindEurope 2022 conference said that the trend of turbine manufacturers selling at a loss will (self-evidently) threaten renewable generation targets.
“The state of the supply chain is ultimately unhealthy right now. It is unhealthy because we have an inflationary market that is beyond what anybody anticipated even last year. Steel is going up three times…It is really ridiculous to think how we can sustain a supply chain in a growing industry with these kind of pressures…Right now, different suppliers within the industry are reducing their footprint, they are reducing jobs in Europe. If the government thinks that on a dime, this supply chain is going to be able to turn around and meet two to three times the demand, it is not reasonable,”
– Sheri Hickok, Chief Executive for onshore wind, GE Renewable Energy
On the upside... We know how corrupt the current government is, so it's a rolling eyebrow guess that new strike price rules will be announced in the summer, and just like that, the sector goes back up.
Hi Actuary.
I didn't highlight rising material costs. That's just a factor, and interest rates are also a factor.
I believe it is mainly do with the subsidy rules as outlined in my post and the article.
It is simply ridiculous that the price would be expected to continually fall, and I completely agree with the comments by the CEO of SSE.
Sadly it's in the hands of the UK government.
Hello Gavster,
Rising material costs are a problem for projects under construction, but UKW invests 99% of its capital in operational wind farms. I am fairly certain that the drop in renewable share prices has little to do with the renewable industry and everything to do with the expected trajectory of interest rates. NCYF and SEQI, which are not renewable energy stocks, have suffered similar falls for this reason.
Reason for the drop outlined in the following article.
https://www.share-talk.com/how-the-uk-offshore-wind-industry-ran-out-of-puff/
Bluefield (BSIF) and Next Energy(NESF) who are part of our sector have also gone down, but not SSE, which could just be held up by investors eyeing their 3.7% dividend in a few weeks.
Article is from 25th June.
The key paragraphs for me in this article I've copy/pasted below.
If this to be all in the hands of Mr Jeremy €unt and our current inept government, then we'll all just have to cross our fingers IMO.
Chart-wise, each bounce and new low keeps being taken out, but strong support at 129.
Cheers and GL.
...
However, a rise in global supply chain costs – spurred by energy price hikes following the Ukraine war – has significantly impeded this progress. Inflation has compelled manufacturers of components, such as turbine blades and nacelles, to ask for higher prices, while increasing interest rates are making project financing more expensive.
...
Many of these challenges aren’t exclusive to the UK but are exacerbated by domestic issues, such as a sluggish planning system and declining British subsidies. These issues are made more evident when compared to the generous financial assistance provided to companies in the US under Joe Biden’s Inflation Reduction Act.
The sector’s challenges are predicted to come to the forefront during the Government’s fifth allocation round (AR5) for the “contracts for difference” (CfD) scheme in the summer.
CfDs are 15-year subsidy agreements between the government and power generation companies, intended to ensure steady revenue streams for energy projects.
In these auctions, companies suggest a “strike price” for their electricity, and the most competitive bids result in subsidy agreements with the Government. When the market price for power falls below the strike price, the company’s revenues are supplemented, and when it exceeds, they remit payments to the Government. Consumer bills fund these CfDs.
However, during this summer’s allocation round, offshore wind faces competition from solar and onshore wind, which are less expensive to construct. Additionally, the maximum strike price for offshore wind has been set at £44 per megawatt hour, a figure that developers argue is impracticably low.
Alistair Phillips-Davies, the CEO of SSE, a company participating in the development of Dogger Bank, warned in May that after years of declining CfD costs, it’s crucial for politicians to reassess pricing, particularly in light of inflation affecting the supply chain.
...
According to Muscat from RenewableUK, there’s still room for adjustments to the AR5 strike price, which she contends should be twice its current rate for offshore wind.
“Developers need the assurance that prices can increase if necessary to reflect economic circumstances,” she adds.
“If the Government’s indicators are that prices can only decrease, then I beli
The article points out exactly what was written in my renewable energy unit in my BSc in 2008. Offshore wind will never be profitable, smaller, local, onshore and decentralised systems with energy storage working with other renewables like geothermal, tidal and PV with a small backup from centralised systems.
Literally saying that transitioning to wind energy is a pipe dream because of the costs of deep water fields is straw manning that all net zero will come from these increasingly expensive systems.
I have a feeling the preference of these projects is down the the massive subsidies and consultation fees that go into the pockets of the few multinationals and consultancy firms who line the pockets of our politicians. Such large scale is not possible with private, home or local based hybrid systems.
Google UK wind subsidies, it's quite obscene, seeing as wind energy companies made huge profits based on the crazy natural gas prices.
Scientific American article says wind energy costs are competitive:
https://blogs.scientificamerican.com/plugged-in/wind-energy-is-one-of-the-cheapest-sources-of-electricity-and-its-getting-cheaper/
The author (Prof Hughes) is not without his critics as there is of REF.
There was an article in the Guardian about the REF.
'The REF has strong links to a group accused of climate science scepticism, the Global Warming Policy Foundation, started by the former chancellor Nigel Lawson, who has denied global heating is a problem.
Prof Michael Kelly, a trustee of the REF also has a position on the board of the GWPF. John Constable, an adviser to the GWPF, has been quoted as an REF spokesperson and was previously its director of policy and research. '
I've been consulting Mr Google on the subject of the true cost of renewable energy. I came across this paper which makes for uncomfortable reading:
https://www.ref.org.uk/ref-blog/365-wind-power-economics-rhetoric-and-reality
It was mentioned at the AGM. There is audio coverage of this event on their web site.
Thanks, Monkshood. I hadn't seen any figure for expected dividend cover. I'd be happy with 2×.
In the Annual Report they said the plan was to pay off the revolving credit debt with longer term debt or by raising equity. They also said that they like buying assets on leverage because the cost of debt was less than the yield on the assets. But maybe that was when interest rates were lower, and they might change their minds now.
I see the share price is well down again today. Looks like I was too impatient, buying at 140p, as usual! Fortunately I still have some dry powder. ;-)
They were expecting 2x divi cover this year so this indicates that they could have around £200m for investment or to reduce debt.
Given the guaranteed steady cash flow and long term nature of the returns I would imagine that they would be able to get very good rates even if they do have to refinance any of the loans.
They have a conference call at the end of July for H1 results so you could ask them about Hornsea debt then.
Correction... I understated the amount of short term debt. From the Annual Report...
"As at 31 December 2022, Aggregate Group Debt was £1,780 million, equating to 31 per cent of GAV (limit 40 per cent). Debt outstanding comprised £900 million of fixed rate term debt at Company level, £200 million drawn under the Company’s revolving credit facility and £680 million being the Group’s share of limited recourse debt in Hornsea 1."
When I said that 1/3 of debt was maturing within 2 years, that was 1/3 of the £900m. The £200m borrowed on the revolving credit facility also needs to be refinanced. I haven't been able to find out anything about the terms of the £680m debt for Hornsea 1.
This is a little disappointing, though as I said, I'm not too worried about higher nominal interest rates, as long as real interest rates are low.