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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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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.
I have two main concerns about the long term future for intermittent renewables, like wind:
1. I suspect that the true cost of electricity from intermittent renewables is much higher than most people realise. I often hear about how cheap renewable energy now is, but I don't think this takes into account the extra costs that are incurred by the system in coping with the intermittency. These extra costs include: electricity from wind being wasted when there's too much of it (I believe the generating company gets paid for the wasted electricity, at the consumer's expense); the cost of batteries that are used to store intermittent electricity for short periods (I think these are mainly used with solar energy); the unit cost of gas-fired electricity being increased because power stations are running at reduced capacity just to fill in when there's not enough wind (so the building and running costs of the power station are spread over fewer units of electricity produced); the grid needing to be expanded to accommodate new wind farms, which tend to be much further from consumers than power stations are. These extra costs fall on the consumer and taxpayer. Over time perhaps the generating companies will be made to shoulder more of the cost. (Consultations are already in progress over a new electricity pricing system, "REMA".)
2. New or improved non-intermittent technologies may replace intermittent ones. I'm thinking mainly of nuclear and geothermal.
On the other hand, the development of cost-effective longer-term energy storage technologies would be good for intermittent renewables, as would cost- effective conversion of surplus electricity to hydrogen.
All in all, I think there a lot of uncertainty about the long term future for intermittent renewables, and that's the one thing that stops me buying more of them.
Actuary -I agree with your conclusion (or I would not be invested here!).
Clearly the high energy prices recently have enabled them to reduce debt, but prior to this I think that a lot of their 're-investment' and growth has come from issuing new equity at a premium which is currently not an option.
Tichtich- It's a good point about the value of the debt/real rates. I also think that the managers have a good conservative approach with the way the business is run, being very selective of the assets they purchase, and the way they manage debt.
I guess for everyone it is about where you think inflation /interest rates will be in the next few years. For us as retail investors it is far easier for us to pivot than II's, so although I try and keep reasonably diversified I do wonder whether I should? I did consider ditching the 'alternatives ' once it was clear interest rates were on the way up, I got out of Reits but kept my holdings here at at BBGI as there was a degree of inflation linking .
It's nice to have be able to have a sensible discussion on one of these boards- thanks.
All good points, Monkshood.
From a personal point of view, I wouldn't invest in long term fixed income bonds, because I'm afraid that we're entering a long period of higher inflation. I'm already semi-retired, and part of my income is from a fixed annuity, which is really hurt by inflation, so I want to hedge by making sure my investment income is well protected from inflation.
For pension funds/companies with fixed liabilities (such as the one paying my annuity) it makes sense to invest in fixed income bonds. But I wonder whether some pension funds are exposing themselves to excessive inflation risk by holding too much fixed income.
Anyway, getting back to the subject of UKW, I had a look at their last annual report the other day, and one of the things I particularly looked out for was how exposed they are to increasing interest rates. One good point is that their gearing is only about 30%, which is lower than other renewables companies I've looked at. It's also good that they have some pretty long maturity debt at low interest rates. Not so good is that about a third of their debt is due to mature within the next 2 years. If they roll over that debt, it will presumably have to be at a much higher rate than they are currently paying. But perhaps they will be able to pay down some of that debt out of whatever remains from last year's windfall or next year's profits.
Anyway, I'm not too worried about interest on debts, because I expect_real_ interest rates to remain low. The short term cost of higher nominal rates is offset by the fact that the real value of the debt is being slashed by inflation.
Hello Monkshood,
You are correct that UKW shares are more risky than gilts and should offer a risk premium. The long gilt yield is currently 4.5% per annum, so if future inflation were 3% per annum, the real gilt yield would be 1.5% per annum. The real yield on UKW shares is currently 6% per annum, implying a risk premium of 4.5% per annum relative to gilts.
As for maintaining UKW's inflation-linked dividend, this has been achieved by re-investing a large share of the profits to grow the assets of the business. High energy prices have produced a temporary windfall, but the valuation model in the accounts assumes that energy prices will fall to more normal levels. Gearing currently gives a 2% per annum uplift to the return on equity, so this margin will reduce (but not disappear) with higher borrowing costs.
Ultimately, it comes down to whether you believe the current risk premium is sufficient. Given the high dividend coverage and growing demand for green energy, it looks sufficient to me.
Actuary,- You make a good point but it does ignore the premium you need when compared to the risk free element of gilts.
Although a tranche of UKW's income is inflation linked, not all is. They have debt which will cost more to service when it comes up for renewal, the assets also have a (fairly) fixed life span. There are other risks, both from government intervention and possible extreme weather events.
Will UKW be able to maintain inflation linkage of their divis over the longer term?
For large pension funds looking decades ahead the risk free element of a high fixed return tips the balance increasingly in that direction with every rate increase.
I couldn't find that article.
UKW has money in its coffers so I don't see why their broker would be forcing some of their investors to sell to raise capital.
But, as always with private investors, we are always the last to know the true picture.
ATB.
@Gavster-NBC
Just a guess, FT had an article about forced selling.
Hello everyone,
I agree that higher bond yields are probably driving the share price down. However it isn't technically correct to compare the yield from an inflation-linked income stream like UKW with the yield on fixed interest securities.
The appropriate metric to compare the UKW dividend yield with is the expected real bond yield, i.e. the nominal yield minus expected future inflation. If we assume expected future inflation = 4% per annum, UKW is providing a higher yield than all but the most risky bonds.
Thanks all.
Another director buys up shares at 140p spending £140,000.
Good enough for them, good enough for us Retail ?
The opinion that the SP goes down for a higher yield due to interest rates is very valid IMO. Seems to be happening all over and we've all been expecting TBH, but for me I still expected that last bounce up towards ex-div. Reminds of a famous interview with W Buffet where he talks about the bargains during high inflation back when he started investing.
@Foobar why Odey Asset Management ?
They are not listed anywhere here : https://www.morningstar.com/cefs/xlon/ukw/ownership
Why the drop ?
Market sentiment..... Even high yielders like IMB & LGEN are sat 15-20% lower than their 12 month highs.
I wouldn't add any more UKW at 150p or more but will show nterest n the 130's
In my opinion, it's mainly interest rates. We saw a similar drop (even lower) last year after the Truss mini-budget. There may also be a significant contribution from lower gas/electricity prices. It will be interesting to say what happens if we have a much colder winter this year.
I try not to worry about a falling share price, as I'm holding for the dividends over the long term. A lower price can even be a good thing if you want to buy more. Of course, it's another matter if the falling share price reflects an actual worsening of the company's prospects. I don't think that's the case here (or I wouldn't have just bought some more).
2. Low gas prices are probably having some effect too
Probably a combination of falling energy price, low wind (at least in the North/Ireland where they have the majority of turbines) and the prospect higher for longer interest rates.
You can get 2 year UK Gilts paying 5% now so the attraction of alternatives has diminished. You can see this across the board, most Infrastructure funds, REITs etc are also well down.
The other issue that a lot of these sectors have is that they can now no longer issue shares at a premium so it has also reduced their cash/liquidity . In past circumstances UKW would probably have issued shares by now to reduce debt and put themselves in a position to purchase another windfarm.
Possibly Odey Asset Management is selling.
I am in the same boat, these were flying a few months ago, something has spooked the share price, thinking of adding but not yet.