Why a portfolio approach is the key to renewable infrastructure investment
Sometimes it's all about timing. At other times, it's about doing the right thing. And sometimes, as in the case of renewables, it's both.
Renewable energy has rapidly become a core component of infrastructure portfolios for retail and institutional investors alike, and can only increase its share of the market as the world moves away from fossil fuels.
This asset class offers compelling and stable yields and uncorrelated characteristics, making it a popular defensive choice.
In addition, we find ourselves in a historic moment as governments worldwide strive to lower carbon emissions.
The opportunity for Australian income investors is clear.
As our aging coal fleet is due to retire in the coming years and the cost of renewables is falling, clean energy is primed to provide the bulk of power generation. This has opened up a $170 billion investment opportunity.
In this wire, I explore the distinctive characteristics of renewable energy infrastructure investments and why investors in Australian assets need to take a portfolio approach.
The frustrating search for yield
Income investors are still struggling to find asset classes able to provide sustainable yields. This places renewable energy in a unique position.
This asset class has these core characteristics:
- The fuel sources of wind and sun are not correlated with markets.
- Low ongoing operational and capital expenditures result in high cash generation.
- Local environmental, social and governance aspirations are aligned with global trends and policy objectives.
This adds up to a compelling investment opportunity for income investors.
Look at the big picture
At the forefront of our strategy discussions and conversations with investors is how portfolio construction and investment structures for Australian renewables are evolving.
More consideration is being given to the wider energy-market context, considering such factors as pricing, policy and grid, and how renewables are now driving the conversation on all fronts.
Traditional methods of investing in renewables, such as buying into single assets or specific technologies, have succeeded in other jurisdictions where subsidies are the primary driver of returns.
They are not as effective in an environment such as Australia, where renewable energy investment is driven by cost comparisons with traditional forms of fossil fuel energy.
As renewables begin to displace thermal energy, owners of clean energy assets need to understand how the wider energy market is affected and how to tap into the value created by that displacement.
Owning just a single asset or technology limits an investor's ability to actively manage this exposure and capture value.
However, owning a singular portfolio of clean energy capacity that is designed to capitalise on the specific energy supply and demand dynamics can achieve this.
Such a portfolio needs the following characteristics:
- A mix of technologies that match generation with demand levels throughout the entire day. Selecting these assets should be backed up by a data-driven analysis of what technologies best serve the market on the most stable parts of the energy grid.
- The ability to trade energy as a singular portfolio to access energy buyer liquidity (and thus sustainable revenues for investors) as well as capture energy price premia (upside for investors).
- A dedicated team to manage the full lifecycle of assets from strategic development and portfolio construction through to energy trading.
What’s unique about this approach is that its not that unique at all! This is how all large energy retailers manage their portfolios of generating assets.
What’s new is a fund manager taking this approach with clean energy assets for the benefit of infrastructure investors.
We firmly believe single asset exposures are going to be increasingly difficult to manage.
Risks will become more difficult to mitigate without a multi-asset, total portfolio approach.
Investors with a longer-term horizon who back the right team and portfolio strategy will gain exposure to an actively managed portfolio where risk is mitigated and upside is pursued.
This will inevitably mean there will be winners and losers in terms of investments into the asset class and a divergence of investment experiences.
How to proceed
A portfolio approach based on sound construction is key. Taking an exposure to a single asset or a collection of single-asset exposures limits the revenue optimisation and risk-mitigation strategies available to a uniformly held portfolio.
To take a portfolio approach, you need the right team with the appropriate skill sets, in order to identify the right assets and manage them for the long term.
Part of portfolio construction will be also having development capabilities within the firm. With the diversity of skill sets within Octopus Australia, we are able to start the investment opportunity at an earlier point in the overall cycle (development to operations), which flows through to our OREO investors by providing a deeper pool of top-quality assets.
This way investors will not be subject to what independent developers have available. And the investment team can therefore be more active in deciding what assets are best placed to enhance the overall value of the portfolio.
What we're doing
We have invested heavily in our team, which is now 25 people, focused on development, engineering, operations, grid and importantly, and investments.
We have also spent a lot of time creating our product structure. It has been designed as a pooled vehicle that aligns our wholesale and institutional investors into a single portfolio.
We believe this is the best way for wholesale and institutional investors to gain exposure to this asset class.
Each investor benefits from the scale, singular trading strategy, portfolio construction strategy and liquidity that a wider portfolio presents.
A trip to Queensland
We recently announced the acquisition of a 180-megawatt wind farm at Dulacca, Queensland.
The site’s generation is 70% contracted with the state government company CleanCo via a fixed-price power purchase agreement.
The site has strong cash yields that underpin our income-focused fund offering, Octopus Renewable Energy Opportunities. Its target yield of 4-5% is competitive on a risk-adjusted basis with investments on similar credit metrics.
The asset fits well with our portfolio construction metrics. Queensland wind assets are particularly valuable given the inverse relationship between solar resources and wind resources.
Dulacca is well placed to capture peak energy pricing in the evening and is a good cornerstone asset for us to build our Queensland strategy around.
Headwinds? More like a learning curve
A lot of the headwinds we face at present relate to education. We are asking investors to approach renewables in a way they haven’t always approached infrastructure investment, ie, as a portfolio of capacity instead of direct interests in specific assets.
Energy market dynamics are complex and it is vital to present data-driven analysis that investors can clearly understand.
It is also imperative to have the right team with diverse skills and technical knowledge.
Renewables are not all alike and an investor's experience will vary, based on the careful selection of best-in-class assets.
Access income while building Australia's clean energy future
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Sam is responsible for the strategic direction of Octopus Investments. He joined in 2012, and was previously Head of Energy Investments in London, where he was responsible for $2.1 billion of investment into UK and European renewable energy assets.