Renewable energy funds are stuck between a ROC and a hard place

The UK renewable energy sector cannot catch a break. At the end of October, the government launched a consultation on changing the Renewables Obligation Certificate (ROC) scheme that subsidises some renewable-energy production. At present, the subsidies are linked to inflation using the retail price index (RPI) measure, but they may now be switched to the consumer price index (CPI). RPI usually rises faster than CPI (the gap varies, but one percentage point is a rough rule of thumb), and so this would mean that subsidies rise more slowly in future.

The government has proposed two options for this. One is to switch to CPI in 2026. The other is backdate the change to 2002 (when ROCs were introduced) by freezing the current price until a new “shadow price” linked to CPI since 2002 catches up with today’s RPI-linked price, and thereafter increase with CPI. Neither are good, but the latter option is clearly worse. Hence shares in listed renewable energy investment funds (REIFs) slumped further, having already been battered by a series of setbacks and problems in recent years.

The changes would have no direct impact on new investments – the ROC schemes closed to most new applications in 2017. However, existing wind and solar farms have been promised subsidy payments until 2037 in some cases, so the changes will affect their earnings. More broadly, making retrospective changes undermines the assumptions on which existing investments have been made. That will erode investors’ confidence in committing future capital.

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While the subsidies are ultimately paid by users as part of their energy bill, the change from indexing on RPI to using CPI is likely to mean a minimal reduction in the average household bill. At the same time, it will probably raise the cost of capital for future projects, making it ultimately self-defeating, argue infrastructure funds. Certainly, one has to feel that the government’s Clean Power 2030 (CP30) plan – which assumes £40 billion of private investment a year in green energy between now and 2030 – now seems wildly optimistic.

Losing patience with renewable energy funds

The direct impact of the change on listed REIFs will depend on which option is chosen (and on how much ROCs contribute to their income – typically 40%-50%). For many investors, this may feel like the final straw – yet more evidence that the sector is both unlucky and dysfunctional. While the government is clearly to blame for this particular shock, the way that the REIF sector has developed in recent years hasn’t encouraged investors to give it the benefit of the doubt. One can’t treat all REIFs as exactly the same and I’m going to focus largely on the solar funds here, but many of the problems apply more widely.

Bluefield Solar Income Fund (LSE: BSIF), Foresight Solar Fund (LSE: FSFL) and NextEnergy Solar Fund (LSE: NESF) put out statements saying that the impact on net asset value (NAV) would be around 2%, 1.6% and 2% respectively under option one and 10%, 10.2% and 9% under option two. This sounds manageable. However, we immediately get onto the question of how much investors trust these reported NAVs, which are based on fair value accounting and “mark to model” assumptions. The fact that most REIFs trade on 30%-40% discounts to NAV implies some scepticism about these valuations, while the fact that dividend yields are in the 10%-15% range suggests some concerns about their sustainability.

The original sin in the REIF model is that it was built around being able consistently to issue shares at premiums to NAV to fund new projects. REIFs were marketed as a growing income story in a low-yield world, with the added bonus of a green angle during the economic, social and governance (ESG) boom. Yet they were always paying out cash with one hand while taking it in with the other (hence NESF’s shares outstanding have doubled from 278 million 10 years ago to 555 million currently). This model only worked when the shares traded at a premium to NAV – now that they don’t, the REIFs no longer have access to cheap equity. Debt is no longer cheap either. It might make sense to cut dividends and reinvest the cash, but that would alienate investors who bought for income.

While this explains their growth problem, the opaqueness of returns explains why many investors are wary of them even as a limited-life income asset. In theory, the NAV represents the current value of future expected cash flows. The focus on this – and on paying steady dividends – makes it look as if REIFs have very simple, predictable economics. Reality is more complicated. Projected revenues depend on power price forecasts that come from third-party forecasters. When these change, so do NAVs. Meanwhile, actual performance has plenty of real-world complications.

For solar, there’s the amount of sun that falls on the panels. There’s whether it all gets used or whether grid outages means some gets wasted (FSFL had UK production 8.9% above budget in the first half, but would have been 13% higher without outages). On sunny summer days, there will be points when a surplus of solar power floods the system and sets the marginal price (at extremes the unsubsidised price can even go negative). Hence the “capture price” that solar farms get can sometimes be less the base load price (the price for steady, always-on power) – this summer, capture rates have frequently dropped to 80%. And if the grid physically can’t cope with the power being supplied, producers may be curtailed (turned off) by the system operator, meaning lost revenue.

Since the REIFs’ lenders and shareholders prioritise stability, the managers fix prices for much of their output in advance with power purchase agreements (PPAs). However, this means that they don’t capture much upside from spikes in spot prices (driven by higher gas prices, which set the marginal UK power price most of the time). All these factors come together in a bewildering series of assumptions. To take just one example, NESF’s short-term power price assumptions have fallen 56% from £139 per megawatt hour (MWh) in September 2022 to £61/MWh in September 2025. Longer-term power price assumption has risen 22% over the same three-year period. Yet its 20-year average price forecast has halved since it floated in 2014, pointing to long-term downward pressure.

Can renewable energy funds win back nervous investors?

What is the result of trying to distil such complexity into a single NAV that constantly changes? It is doubt about whether management are trying to mask poor economics with financial engineering, unconsolidated statements, fair value accounting and unverified assumptions. The accounting might technically be correct, but it is opaque and hard to compare between funds. Each time forecasts prove too optimistic and NAVs get downgraded, scepticism grows. This is why the REIFs now trade at huge discounts to NAV. (Policy risk – as demonstrated by the government’s proposed ROC change – may be another factor.)

Most of the REIFs seem to have little idea of how to get investors to trust them. They have tried to address the discount to NAV with share buyback programmes, but these have been too insignificant to counter the wave of selling. What’s more, buybacks often increase leverage: in May this year, NESF had to pause its buyback as leverage would have increased beyond its 50% debt-to-gross asset value policy limit. Rising debt is exactly what nervous investors don’t want to see.

Many have tried to sell assets, which would raise cash to pay down debt and fund buybacks while also validating NAV through real-world selling prices. This process has been slow, suggesting it may be hard to achieve prices respectably close to NAV. For example, in April 2023 NESF said it would sell 246MW of UK subsidy-free solar capacity across five separate projects. At present, there are still two project with 100MW yet to be sold. Last year, FSFL said it would sell its Australian portfolio (170MW across four sites), but the process has now been paused. A small number of bids for the portfolio were received, but none were deemed deliverable. In March this year, it earmarked a further 75MW for sale, with no results so far.

More recently, Bluefield proposed merging with its manager to focus on developing a 1.4GW pipeline of projects. However, that model implied a cut to the dividend and was quickly rejected by shareholders (if they were sceptical about the potential returns on capital, it is not surprising given the sector’s record). The fund was forced to ditch this and put itself up for sale. This has not steadied the decline in the share price, which has fallen to new lows below 70p, with a yield of 13% and a discount to NAV of 39%.

Until now, REIFs that have faced continuation votes have largely won them despite these woes – probably because investors are sceptical that they can sell their assets, pay back the debt and achieve a decent return for shareholders. This detente may be changing as investors get more anxious. The chairs of NESF, FSFL and BSIF have all stepped down in the past year and new brooms may be minded to sweep clean.

We could be reaching the point of maximum pessimism, as seems to have happened with battery funds. I have a position in NESF, bought on the basis that the dividend could well be cut, but that much of the bad news was already in the price with a yield in the mid-teens. Still, if the REIFs’ accounts clearly told us how much cash is being generated per pound invested per MW and whether it is declining, it would be much easier for investors to decide whether they still want to back these “sustainable” investments.

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