UK Onshore Wind www.fimltd.co.uk Investment Fundamentals
Wind is a proven asset class for both private and institutional direct investors. UK wind provides investors with a low risk investment. It is 100% asset backed and provides robust revenues with a strong degree of inflation protection. 1
Introduction Installed wind capacity in the UK has seen annual growth rates of over 20% since 2010, with 15.6 gigawatts ( GW ) now operational, spread over 8,800 installations. During 2016 for the first time the UK generated more electricity from wind than from coal, with wind energy providing 12% of total electricity supplied. This exceptional growth has been driven by government energy policy and financial support, predictable output, consistent reductions in capital and maintenance costs and increased efficiency of generation technologies. This gives direct investors the opportunity to hold a sustainable real asset with an attractive return and low financial risk in today s uncertain economic environment. Contents Section 1: Why UK Onshore Wind? Section 2: Drivers of Return Section 3: Asset Life and Generation Section 4: Attractive Distribution Profile Section 5: FIM Origination and Asset Management The main government support regime for onshore wind, the Renewables Obligation (the RO ) ended in 2016 for new projects not eligible for various grace period exemptions. This is expected to significantly decrease new onshore wind development in the short to medium term. However, existing operational assets with a proven track record continue to be in high demand and consolidation in the secondary market towards long term asset holders is leading to yield compression. This trend is likely to further increase as the pool of high quality and available assets decreases over the next two to three years. Onshore wind is a mature technology with low operating risk (operating costs are largely fixed) and once operational, benefits from up to 20 year fixed, index-linked, government backed revenues. There is an opportunity to acquire operational assets over the next two to three years to benefit from long term stable cash flows, with potential future upside from increases in power prices and further yield compression. UK Onshore Wind 2
Background to FIM Established in 1979, FIM has nearly 40 years experience of acquiring and managing UK sustainable real assets. FIM have a proven capability in originating, acquiring, constructing and managing the operation of UK renewable energy infrastructure assets. Funds under management are c. 825 million, encompassing over 77,000 hectares of forestry and 127 megawatts ( MW ) of renewable energy plants in onshore wind and solar PV. Our expanding client base includes funds, high net worth individuals, family offices and institutional investors. In this paper we discuss the fundamentals of operational onshore wind as a direct investment, including the drivers of returns and future opportunities. To discuss anything referenced in this paper, please contact us by email at fim@fimltd.co.uk or on 01451 844655. 3
Section 1: Why UK Onshore Wind? The rationale for long term investment in UK onshore wind continues to be compelling, due to the benefits of: Highly cash generative assets with a 30+ year economic life; Well established, proven technology, backed by long term maintenance contracts with excellent performance guarantees; Low volatility in annual output with robust post construction energy forecasts, ensuring robust cash distributions; c.50% of the revenue coming from fixed, indexlinked government support secured for 20 years once operational, Renewable Obligation Certificates ( ROCs ) payable under the RO; Exposure to the potential substantial upside in UK power prices forecast over the life of the asset; and Further yield compression due to an ongoing shift towards long term asset holders and slowdown in the development pipeline. 4
Section 1: Why UK Onshore Wind? European Wind Resource Map The UK is one of the best locations for wind power in the world with a well established industry, a long term secure government support regime for operational assets and the best wind resource in Europe. The UK s wind resource is derived from its long, exposed coastlines and low mountain ranges. Excellent wind speeds means that the UK accounts for approximately 40% of Europe s wind resource and typically provides capacity factors at onshore wind farms of c.30% and offshore wind farms of c.40%. Source: European Wind Energy Association The UK has experienced substantial growth in onshore wind capacity since 2002 as shown in the chart below, benefitting from falling turbine prices and the attractive index-linked 20 year UK ROC regime. MW 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - UK Wind Deployment Given this excellent renewable resource, installed capacity has now exceeded 15GW, comprising of 5GW of offshore wind, 9.9GW of onshore wind built under the RO and small scale assets supported by the Feed in Tariff ( FIT ) scheme totalling 0.7GW. The removal of government support for new UK onshore wind projects in 2016 is likely to significantly reduce new capacity deployment in the short and medium term. The industry is well established in the UK, Europe and globally such that reducing capital and operating costs and technological improvements are expected to continue and deliver subsidy free developments in the future. Source: Ofgem Offshore Wind RO Onshore Wind RO Onshore Wind FIT 5
Section 1: Why UK Onshore Wind? Proven Technology Wind turbine technology is the most mature renewable energy technology. While there have been significant technological advancements over the last 10 years, both in terms of size and efficiency, the basic principle of wind technology remains the same: the wind (kinetic energy) turns the turbine blades, which turn a shaft within the nacelle which turns a generator converting kinetic energy into electrical energy. The electricity is fed into a transformer, either inside or outside the turbine, which steps up the voltage to reduce electrical losses in transportation. From there the electricity is transported via underground cables to a substation where the voltage is stepped up further and exported onto the local distribution network or directly onto the transmission network. Turbines start to generate electricity at low wind speeds, typically of 3-4m/s (7-9mph) which in the UK is generally experienced for 75%-85% of the time. The amount of electricity generated from a site increases with wind speed up to c.15m/s (34mph) where the maximum output of the turbine is reached. Output is then maintained at this level until a turbine automatically shuts down when the wind reaches speeds of c.25m/s (57mph), to protect itself from storm damage. Wind turbines are often criticised for being inefficient because on average they are operating at c.30% of their total potential capacity. Wind turbines are designed to be able to operate up to their maximum capacity when the wind is in optimum conditions, which for generation is not going to be all the time. What is important is the cost of each unit (MWh) of electricity generated from wind compared to alternative technologies. The latest report published by the Department for Business, Energy and Industrial Strategy ( BEIS ) shows that for projects expected to be commissioned by 2025, onshore wind and solar will be the cheapest sources of generation technologies on a Levelised Cost of Energy basis ( LCOE ). The LCOE takes into account the total cost of generating electricity from development costs through to construction and operating costs and is therefore considered the fairest method of comparing the cost of energy across all technologies. Wind and Solar will soon be the cheapest form of electricity generation. /MWh 250 200 150 100 50 0 Levelised Cost Estimates for Projects Commissioning in 2025 /MWh Nuclear PWR Coal - ASC with oxy co mb.cc S CC GT with pos t co mb. CC S Pre Development Costs Fixed O&M Fuel Costs Coal -IGCC with C CS CC GT H Class OCGT 600MW (50 0hrs) Con structio n Costs Variable O&M Carbon Costs Offsh ore R3 Source: BEIS Electricity Generation Cost Report November 2016 Large Scale Solar PV On shore >5MW UK 6
Section 2: Drivers of Return Increasing demand for onshore wind assets and a slowdown in supply will increase values in the short and medium term. Robust Revenues Typically, c.50% of UK onshore wind income derives from a government support scheme, the RO, a locked in 20 year index-linked price per MWh of power generated. This support is grandfathered, meaning any potential future changes to the support scheme will not affect existing accredited sites. The wholesale electricity price provides the majority of the remaining income generated (2017: c. 40/MWh). It is widely forecast that power prices will increase at a rate beyond inflation, due to a number of factors including growing power demand and constrained supply in the UK. The Other revenue shown on the left consists of: embedded benefits which small generators earn by being located close to electricity demand and ROC recycle payments, which vary dependent upon the percentage of ROCs generated in total versus the obligations placed on licensed suppliers in any given year. Historically, power price increases have exceeded inflation over the medium and long term and it is FIM s view that this, along with inflation linked ROCs, will continue to provide investors with an inflation hedge. Illustrative Breakdown of Wind Farm Revenue c 5% Other Wholesale electricity prices are variable and exceeded c 45% RPI over the last decade UK Government backed scheme (ROCs), fixed and linked to RPI c 50% Source: Ofgem; Mitie As c.50% of the revenue is the legislated index-linked ROC, the potential for upside for onshore wind investors will come directly from the rate of increase in the wholesale electricity power price, the rate of inflation and life extensions. Yield Compression The RO closed to new onshore wind capacity in 2016, there are certain grace periods still available for onshore wind but the number of new projects being developed in the short and medium term will be significantly reduced. Costs for onshore wind continue to fall and projects will soon be developed subsidy free. In the short to medium term there will be increasing demand for a shrinking pool of available operational assets as long term investors continue to grow their market share. The security of onshore wind s index-linked ROC cash flow has proved highly attractive to institutional investors. Given rapidly reducing capital and operating costs it is highly unlikely that new government support will be introduced. Without widespread fixed price Power Purchase Agreements ( PPAs ), subsidy free renewable assets will be fully exposed to the wholesale power price market offering a higher risk asset. Onshore wind assets accredited under the RO are likely to be considered a lower risk alternative and of preference to institutional grade investors, resulting in ongoing yield compression. 7
Section 2: Drivers of Return UK electricity demand growth is linked to population growth, GDP growth and increasingly to the decarbonisation of the economy. The National Grid is the designated System Operator for the UK, responsible for the real time balancing of electricity supply and demand. It devotes significant resources to forecast how it can maintain a reliable and fully functioning electricity system, both now and into the future. In July 2016 it released its annual report titled Future Energy Scenarios ( FES ). It is evident from the chart on the right, which summarises National Grid s upper and lower demand forecasts, that they consider that the lower limit of future demand to be similar to current levels. However, the upper limit is significantly above current levels, driven by population growth and electrification of the heating and transport sectors. The extent to which demand rises will depend on the extent of the electrification of these sectors and economic cycles. Electrification of the transport sector is now firmly underway, whilst the heating sector remains a largely untapped but potentially huge source of future demand growth. A new EU directive aims to ensure every new home and 10% of parking spaces in Europe has an Electric Vehicle ( EV ) charging point. Battery costs have fallen by 65% since 2010, new EV models are being released with 200+ mile range and the cars themselves are becoming more and more affordable, with Tesla s much anticipated Model 3 starting at just over $30,000. Unsurprisingly, global sales are forecast to show similar growth rates to that witnessed in the renewable energy sector at the start of the decade. Only a modest amount of growth from the transport and heating sectors is currently factored into long term power price forecasts, suggesting significant upside on future demand and thus power prices. Electrification of the transport sector will cause ongoing growth in electricity demand. TWh National Grid Forecast UK Electricity Demand 410 390 370 350 330 310 290 270 250 2017 2022 2027 2032 2037 Upper Limit Source: National Lo Grid wer (FES Limit report, 2016) Source: Future Energy Scenarios July 2016 8
Section 2: Drivers of Return The Future Power Supply Mix The UK is due to witness a huge change in its power generation mix over the next 10 years. All coal capacity (14GW) is due to be decommissioned by 2025 (following on from 4GW of closures in 2016) and 9GW of nuclear capacity is forecast to shutdown between 2025 and 2035. Overall c.25% of the UK s current generating capacity of c.97gw is expected to be decommissioned by 2035. The extent and potential timeline of these closures has long been known and the government had expected new build gas to maintain the UK s security of supply in the short to medium term. The significant capital costs required to build new large scale gas plants is expected to require energy prices of between 65 and 80/MWh to justify investments. Therefore the current wholesale price of c. 40/ MWh is insufficient to incentivise the additional private investment the government desires. The Capacity Market ( CM ), set up to secure system supply during this period of structural change, has awarded contracts to c.8gw of new capacity for delivery between 2018 and 2021. However, due to a combination of lower than expected auction clearing prices and general uncertainty in the market, a significant proportion of this capacity is unlikely to be built. Carlton Power s 1.9GW Trafford Gas Power Plant, the largest new build project to be awarded a contract under the CM, has failed to meet its financial commitment milestone and Carlton Power have informed BEIS that they will give up the 450 million subsidised contract. It is widely expected that more new build projects already awarded CM contracts will follow suit. The lack of market driven new build and likely further withdrawals from the CM should lead to a tightening of system supply and an increase in energy prices around periods of system stress in the short and medium term. In the longer term these problems are likely to persist, unless there is a significant rise in the wholesale electricity price to facilitate market driven new build. 9
Section 2: Drivers of Return Electricity Price Outlook The combination of increased demand for electricity over the long term and constrained supply, provides the fundamentals for higher electricity prices in the future. The chart on the right from the recent National Grid FES study highlights the upside potential for electricity prices. These could rise towards 60/MWh in the medium term, which is some 50% higher than the current wholesale price. This higher price scenario is notably consistent with the historic linear trend for power prices over the last decade, indicating the clear potential to enhance investment returns. Britain s pending exit from the EU causes significant uncertainty regarding the relationship between the UK and EU s energy markets. In the short term, energy prices are likely to rise as the cost of imported commodities such as coal and gas increase. Uncertainty is also likely to have medium term impacts as new build developers adopt a wait and see approach, which will put further pressure on already tight electricity supply margins and further delay much needed new capacity. /MWh 90 80 70 60 50 40 30 20 10 0 UK Baseload Electricity Price Projection 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 Historic Base Case High Lo w Linear (Historic) Source: National Grid FES report (July 2016) Day Ahead Wholesale Price Pre & Post Brexit Vote Therefore FIM s view is that now is an opportune time to acquire onshore wind assets, in order to benefit from the potential upside in future power prices. /MWh 70 60 50 40 30 Brexit French Nuclear Outages Article 50 20 10 0 Jan -16 Feb-16 Mar- 16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oc t-16 Nov-1 6 Dec-16 Jan -17 Feb-17 Mar- 17 Apr-17 May-17 Source: Mitie & ONS 10
Section 3: Asset Life and Generation The first mass produced wind turbines, the Vestas 30kW machines, have been operational since 1980 without the need for major component replacement. LF 30% 25% 20% 15% 10% 5% 0% Onshore Wind RO Sites Average Annual Load Factor ( LF ) 2011 2012 2013 2014 2015 2016 Knots 9.6 9.4 9.2 9 8.8 8.6 8.4 8.2 8 7.8 7.6 7.4 Competition and technological growth within the wind turbine manufacturing industry has led to significant improvements in turbine performance and reliability. Major components have a design life of at least 25 years. Operations and Maintenance contracts are usually provided by the manufacturer, and offer availability guarantees of c.95% for up to 30 years. The first mass produced wind turbines, the Vestas 30kW machines, have been operational since 1980 without the need for major component replacement. Output from onshore wind generating assets can vary from day to day but volatility is low on an annual basis. The chart to the left demonstrates how the standard deviation in output for onshore wind assets operating between 2011 and 2016 is less than 10%. FIM believe that life extensions to wind farms will become normal as assets are shown to be economically effective beyond 30 years and become an even more integral part of the electricity network. This will provide significant upside for investors as current acquisition prices do not reflect this potential. RO Sites Average Annual Load Factor (Ofgem) Average Annual Wind Speed (BEIS) Source: Ofgem Register; Met Office Wind Data 11
Section 4: Attractive Distribution Profile A typical wind farm s cash distribution profile is expected to rise with inflation and rising energy prices. The majority of wind farm assets are held in limited company structures with debt in place. For a leveraged wind farm, due to relatively low and fixed operating costs, c.40% of revenues would still be expected to be available for dividends with an average dividend yield of c.10% over the life of the project. Tax relief on the capital cost of plant and machinery means that little or no corporation tax would be expected to be paid in the early years of the project. Cash flows from wind farms are relatively stable; c.50% of the revenue stream is index-linked (the ROC revenue), operating costs are low (c.30% of revenue), and inter-annual variability of output is low, providing annuity type cash flows from these assets. 20MW Wind Farm Indicative Cash Flow '000 End of ROCs 12,000 10,000 8,000 6,000 4,000 2,000 0 2018 2022 2026 2030 2034 2038 2042 2046 Revenue Operating Costs Corporation Tax Debt Service Dividend Source: FIM FORECAST AVERAGE ANNUAL DIVIDENDS YEARS 1-10 YEARS 11-20 YEARS 21-30 7% 13% 13% 12
Section 5: FIM Origination and Asset Management FIM will invest only into operational onshore wind assets which use top tier reliable equipment. FIM is accredited to ISO 9001, ensuring robust operating procedures and effective corporate governance. Asset Acquisition/Enhancement FIM has a proven track record of maximising returns and minimising risk from renewable energy projects through: Acquisitions: selective purchases (proven developers, respected construction firms, quality asset owners) FIM has proven its value on acquisitions for investors by: Originating a regular supply of attractive investment opportunities. The ability to source and deliver opportunistic and off market transactions. Operate and Maintain Acquired/Built Sold Implementing a rigorous financial, technical and legal due diligence process for every purchase. Active Management: enhancing returns Well structured operations and maintenance contracts maximise output from the wind farm and also minimise lifecycle costs. FIM has a dedicated asset management team for renewable energy assets, ensuring close monitoring of costs and performance optimisation. FIM s ongoing tracking of the power price market also informs decisions of how to sell power to secure the best available prices. Improving returns through life extensions and repowering. 13
Section 5: FIM Origination and Asset Management Independent advice on realisation FIM acts solely to maximise our investors returns. FIM s independence allows detailed return driven advice to be provided to investors. Asset Risk Management A well selected and well managed portfolio with diversified geographic locations and equipment suppliers will minimise the residual investment risks. FIM also ensures the procurement of a suitable range of manufacturers warranties and performance guarantees to protect income. Direct Acquisition Opportunities FIM is continually appraising acquisitions for direct investments. Please contact us by email at fim@fimltd.co.uk or on 01451 844655 if you would like further information on current acquisition opportunities. This document does not constitute or form part of any offer for sale or solicitation of any offer to buy or subscribe for any securities nor shall it or any part of it form the basis of or be relied on in connection with, or act as any inducement to enter into, any contract or commitment whatsoever or constitute an invitation or inducement to engage in investment activity under section 21 of the UK Financial Services and Markets Act 2000 nor shall it be deemed to provide investment, tax or accounting advice. This document has been prepared by FIM Services Limited (FIM). By accepting this document, the recipient acknowledges that it will, and it will cause its directors, partners, employees and representatives to use the information contained in this document for information and discussion purposes only and that no reliance may be placed for any purpose whatsoever on the information or opinions contained in this document. FIM does not represent or warrant or give any other undertaking that the information or opinions in this document are accurate or complete. Neither FIM, nor any affiliate, nor any of their respective directors, partners, officers or employees or any representative accepts any liability whatsoever for any direct or consequential loss arising from any use of this document or its contents. 14 14
FIM Services Limited Glebe Barn FIM Services Limited Great Barrington Glebe Barn Burford Great Barrington Oxon Burford OX18 4US Oxon OX18 4US Tel: 01451 844655 Email: Tel: 01451 fim@fimltd.co.uk 844655 FIM Services Limited is accredited to the ISO 9001 standard Email: fim@fimltd.co.uk FIM Services Limited is accredited to the ISO 9001 standard www.fimltd.co.uk