Powerful lure of a renewed sector

The renewable energy sector attracts every type of investor as the technologies advance – particularly in biofuels – the regulatory environment improves and tax efficiencies abound.

One of the challenges – and indeed one of the attractions – of investing in renewable energy, is its diversity. The retail equity market likes proven technology on the cusp of commercialisation. It likes a supportive regulatory environment with a long-term government commitment such as Feed in Tariffs and Renewable Obligations Certificates. Investors are also attracted to projects that can plan for an exit event and are able to offer liquidity during the term of investment. Any tax efficiencies that can be used to enhance returns, or offer downside risk protection, are also attractive.

Furthermore, retail equity tends to favour dedicated funds, tied to specific technologies. Pipelines of real commercial projects at various stages of development are also attractive.

This requires dedicated project development teams. From a marketing perspective, good distribution and an established fund manager are also key requirements. (Strategy continues below)

Growth sectors
Sustainable biofuel projects meet these investment criteria, using proven technology with known commercial results and operating within a supportive regulatory environment.

Furthermore, Britain is ideally suited to domestic biofuel production, with a large transport fleet, a surplus of suitable low-grade feedstock and a petro-chem infrastructure with an associated skilled workforce. British bioethanol is a massive growth sector underpinned by the European Union (EU) renewable energy directive, which mandates fuel retailers to blend 13% (by volume) of liquid transport fuel with non-fossil fuel alternatives by 2020. Furthermore, indirect land use change and sustainability compliance are being bound into both EU and British legislation. Tariff loopholes, which allow unsustainable American ethanol to enter the EU market are also being addressed by an independent European Commission and receiving considerable British government support.

Combined heat and power (CHP) projects offer attractive investment propositions with wide market appeal (domestic and industrial), government support and proven technology – simultaneously delivering commercially viable solutions to Britain’s energy and carbon emission saving requirements. Furthermore, and perhaps most importantly when structuring equity investments, they possess inherent tax efficiencies, which can be used to provide downside risk protection on capital invested.

Tax-based equity
Biofuel and CHP projects usually have large capital expenditure requirements, generating in-year capital allowance relief, which can be used in mitigating tax liabilities. They may also contain expenditure on energy-saving plant and machinery, attracting enhanced capital allowances (ECAs) which generate 100% first-year allowances. Such projects tend to be cited in regeneration areas or enterprise zones which may also attract Business Property Renovation Allowance relief on renovation costs.

Approved government initiatives, such as the enterprise investment scheme (EIS) and venture capital trust (VCT), also provide incentives for inward investment into renewable energy. This area is likely to attract more interest if the EU approves the proposal to increase the maximum investment amount from £2m to £10m

”Combined Heat and Power projects possess inherent tax efficiencies”

VCTs offer similar tax breaks including an exemption on income tax on dividends, but require the investment to be listed on the London Stock Exchange and held for a minimum of five years. The maximum investment an individual can make is £200,000 a year. Both EIS and VCT schemes are attractive as they are seen as government backed, non-aggressive tax efficient investments. However, ensuring compliance with the various investment requirements adds an extra layer of complexity and be administratively burdensome.

An interesting new scheme that is receiving considerable attention is ’seed’ EIS (SEIS) investment schemes for start-ups. This government approved initiative is avaliable from April 2012 and targets companies with less than 25 employees and £200,000 of assets. Benefits include 50% tax relief (even if the tax rate is less than 50%), a CGT holiday if the investor uses a capital gain to invest in a SEIS in 2012/13, and has a maximum individual investment limit of £100,000.

Retail debt
The traditional corporate bond market has a minimum issue of £100m and is not available to small and medium-sized companies. Products often referred to as “mini-bonds” with a fixed term and return have arisen from demand by retail investors. The best known example is Ecotricity, which raised £20m in two tranches – offering a four-year term, 6-7% interest with a minimum investment of £500,000. In Germany, mini-bond initiatives, issued by companies, typically offer 6-7% on five-year bonds, raising anything up to €150m (£124.8m).

Finally, “peer-to-peer” lending offers a micro-finance related credit line for start-up companies. A product of internet technology, this sector has grown from $110m (£69.3m) in 2005 to $5.5 billion in 2011. Doubts about regulation and default rate are risks associated with this finance. Other issues associated with retail debt include unrated ’junk bond’ status (often BBB+/B- credit ratings), not being covered by the Financial Services Compensation Scheme and the inability to invest via a Self Investment Pension Plan or Individual Savings Account.

Investing in renewable energy has come a long way from the niche area it was. The increasing sophistication of the structures on the market means there is a renewable energy investment to suit any investor. As providers within the sector continue to innovate, we expect to see more trends emerge with renewable energy.

Jonathan Turney is an associate director at Future Capital Partners.