Friday, 10 April 2015

Investing in community energy - what to expect

My last post was about investing in solar panels for your home – but your home may not be suitable, or you may not have enough money to hand. You can invest smaller amounts in larger renewable energy projects around the country. I have touched on this before – see Investing in wind – reading the small print. In this post I look at a wider range of projects: three co-ops, a secured loan and debenture, generating renewable energy in the form of wind or solar electricity or biomass heating.

The projects I refer to are these. All are for 20 years except the E2Energy one. E2Energy and Wester Derry are the ones I discussed before. I actually have invested in Wester Derry, and also Reach. E2Energy went ahead and now there is another similar offer called E5Energy you can invest in. SSWoodheat is now fully funded but the Reach and Oakapple are still open or were the last time I looked.

NameRenewables type and capital neededType of investment and estimated returns
(terms explained below).
Reach Solar Farm264 kWp solar farm
Shares in a BenCom, estimated 2-4% return, plus EIS tax relief.
Oakapple, BerwickshireSolar PV on social housing
£3.1 million
Debenture (like an unsecured loan), 7.5% IRR
Wester Derry250kW wind turbine £800,000Shares in an IPS, estimated 7% IRR, plus EIS tax relief
E2Energy5 wind turbines
£1.25 million
Secured loan (3 years) 7.25%
SSWoodheatDistrict heating system using a wood chip boiler, for a charitable care home and some nearby households
Shares in an IPS, estimated 6-7% return, plus EIS tax relief

Before I go further - I am not a financial advisor and I will not be making recommendations. My purpose is to comment on features that are similar and different, to give you some pointers as to what to expect and what to look for. For example, whether the returns are fixed or variable, how they are secured, how you get your money back, assumptions made in estimating returns.

Shares or loan, and is there tax relief?
Reach, Wester Derry and SSWoodheat are co-ops - either a BenCom (‘society for the benefit of the community’) or a traditional IPS (Industrial Provident Society). This has allowed them to qualify for EIS tax relief for their investors, so if you pay tax you can claim back 30% of your investment. The expected rule change on EIS has been delayed but that won’t last long – SITR (Social Investment Tax Relief) will partly take its place see Changes Coming for Community Investment.

You don’t really have to leave your money in for twenty years.
Except for the E2Energy loan, all the projects are for twenty years. The reason for the 20 years is because that is the term of the Feed in Tariffs (FiTs), or the Renewable Heat Incentive (RHI) in the case of SSWoodheat. However, that doesn’t mean you have to leave your money there for twenty years. In all cases, the financial model assumes that some people will take their money out early. In fact, although none of them mention this, if people don’t then it makes sense for the project to buy back some of the shares instead.

The project has to build up a reserve to pay you back at the end.
To explain this it is easiest to consider what happens if everyone leaves all their money in for the whole 20 years. The project has to accumulate capital to pay this back. This money stays in the bank, hopefully earning some interest. However, it isn’t useful to the project at all. Giving it back does not affect the projects’ income. (It is of course necessary to have a small reserve for cash flow and a contingency fund.)

But if you get paid part of the money on the way, the rate of return increases.
Now imagine that after ten years the project buys back half the shares, equally from each person. The income is unchanged, but the share capital is how half. If I started out with an investment of £1000, I now have an investment of £500. But the income to the project is much the same as before – suppose my share is £50. That is a 5% return on £1000 but a 10% return on £500.

Also, it’s nice to get some of the money back early.
Also, if I had a choice, I would rather get my £1,000 back in two chunks of £500 at ten-year intervals rather than one chunk of £1,000 after twenty years. That way I can do something else with my £500 for ten years. This is the logic behind the calculation of IRR (internal rate of return). For a simple fixed rate loan, where you get a fixed percentage each year and the principal returned at the end, the IRR is the same as the interest rate. However, the IRR puts a higher value on money you get back sooner, so if you get some of your principal back early, the IRR is higher.

So do you have a choice?
Oakapple pays back equal amounts of the loan each year and E2Energy is only for three years anyway. For the others you can leave your money in for twenty years. In fact you have to leave your money in for 3 years to get the EIS. But after that, the rules are that you can ask to have your money back and the board might or might not let you. Basically, if they have enough reserve they will. One of the reasons that Reach shows a lower interest rate than the others is that their business model is fairly conservative on how much share capital is taken out. On the other hand, they have assumed that they will get interest on their reserves at the rate of RPI.

What is the percentage return? Is it fixed, constant or variable?
This is an area in which the projects are very different and it is surprisingly hard to compare them fairly.

Reach has used a constant rate of return in their financial model, although this won’t necessarily happen in practice. E2Energy is only for three years anyway and the other projects give you lower returns initially and higher ones later. Wester Derry starts out at only 2.25% and increases to 96% (assuming all the reserve is given back to shareholders each year). Even so, their calculation of IRR at 7% seems to take into account the return of shareholder value each year because if you do leave all your money in to the end I make it 4%. That means Reach and Wester Derry are much more similar than the headline figures suggest. For SSWoodheat there is only a minor increase in interest rate, with 6% offered initially and 7% after three years. After that the excess will be given to the customers, in reduced prices, rather than the investors.

For the co-ops, the returns will have to be agreed by the shareholders each year.
Oakapple has written the increasing return into the debenture agreement – the interest rate rises from 3.3% to 6.3% over twenty years, and the returns are calculated based on the initial investment, not counting the fact that you also get 5% of your investment back each year. For the co-ops, the returns will have to be agreed by the shareholders each year and could vary.

Income depends on inflation, so what assumptions have they made about that?
All of these schemes have some income from subsidy schemes, either the RHI or the FiTs. These subsidies increase with inflation, specifically at the same rate as the RPI, so they will tend to increase through the project. Mostly they assume RPI is 2.5%. However Oakapple has assumed RPI is 2.8%. This value is quite critical in the financial model as it has a large effect on income. On the other hand, if RPI is low then you may be content with a lower return.

What about the weather?
The income from all of these projects depends on the weather. In the case of SSWoodhead, the demand for heat varies with the weather, and in the other cases the renewable energy available depends on how windy or how sunny it is. So you can’t really expect predictable returns each year but on average the bad years and the good years should even out.

Do they expect to sell their electricity for more than the standard Feed in Tariff?
For all except Oakapple there is also some income from energy sales. For the solar farm and wind farms, they can potentially sell their electricity for more than the standard export tariff. For example, Reach has predicted an electricity sales price of 5.3p/kWh, about 0.5p/kWh above the export tariff. (Their pessimistic forecast is based on the standard tariff only). Also, Reach has assumed the electricity sales price increases only with RPI – as does the standard export tariff. However, Wester Derry has assumed a slightly higher initial price (5.56p/kWh) and inflates this a little faster, in line with the trends of the last few years.

Wind and sun are free but woodchip isn’t, and what if the customers don’t pay?
In the case of SSWoodheat, more than half their income will come from selling their energy to actual customers: they expect 6.8p/kWh from the RHI and another 7.24p/kWh from retail price. This income is more risky because there is the possibility that their customers won’t pay on time. Also, their costs are more variable than the other projects because they have to buy fuel (woodchip) and the price of that is not fixed. For the solar and wind projects the ‘fuel ‘is free. Finally, SSWoodheat has a risk that their customers will go elsewhere for their heat. Some of their customers are ordinary homes, probably currently using oil boilers since they are off the gas grid. The price of oil has been very high but has come down a lot recently.

Have they allowed for the solar cells deteriorating?
In the case of the solar panel projects, they should expect a gradual deterioration in the panels leading to a lower yield and lower income. By the end of the twenty years, yield could be down 10-15%. This needs to be allowed for. I am not sure if Oakapple has as they are not explicit about it but Reach certainly has.

Could there be nasty surprises when it comes to installation costs?
The E2Energy offer was based on wind turbines that were already up and running. All the other projects have installation costs, and installations can have problems. It isn’t always possible to get definite quotations for all the installation work in advance of the share offer but then there is some risk that these will have been underestimated. So it is important to have faith in both the knowledge and the honesty of the project team. But then you should never make an investment if you don’t trust the executive team.

I am a bit surprised at the low installation costs for the Oakapple project. They expect to install a total of 2,595kWp on 749 homes, for maybe £3 million (unless there are other funds in the pot that we don't know about). That means an average of 3.5 kWp per home for about £1,150 per kWp, not much more than half the normal price for residential installations. On the other hand this is social housing so there will be much lower administration costs and also bulk discounts on the materials. The project partners are not new to the industry so they really should know what is achievable.

What is the security?
None of these investments are secure. The E2Energy one counts as a secured loan because the wind turbines are used as security for the loan. But not knowing much about the market in second hand wind turbines I find it difficult to judge how risky this is.

Another risk is equipment failure. The SSWoodheat share offer does not mention insurance, which I find surprising. Even when the equipment is guaranteed it often makes sense to have insurance covering loss of earnings. Wester Derry does this.

You should of course take a good look at the risks listed in the share offer document.

You shouldn’t put all your money in a single scheme.
I hope you are not now completely put off the idea of investing in these schemes. All investments have a degree of risk and it would be silly to put your whole savings into one scheme but that doesn’t mean you should avoid them altogether. I can think of a lot of schemes riskier than these.

One way to spread the risk is to invest in funds instead.
It is usual to spread your risk by investing small amounts in a number of schemes, and another way to do that is through a fund. I have found two on the London Stock Exchange that look interesting: Greencoat UK Wind and The Renewables Infrastructure Group. The smallest of these has £300 million to play with, compared to the largest project above being £3 million. With funds there is an annual management fee to pay but the risks are generally smaller.

But then you lose the personal element.
Still, there is a strong appeal to investing in particular projects especially ones near you where you can go and see them and or where you know the people involved. That is partly why I invested in Reach and Wester Derry – I know and trust people on the team. By the way I happen to know that the Reach Solar Farm project was limited in size by the local grid capacity and they hope to be able to expand in the future. If that happens, they could add capacity at relatively low cost and improve the rate of return. But there are no guarantees on that of course.

No comments:

Post a Comment

Comments on this blog are moderated. Your comment will not appear until it has been reviewed.