227. How hydro-electric power could help avoid blackouts in the future

Will Argent, investment adviser to the VT Gravis Clean Energy Income fund, tells us how the clean energy space has evolved in the last 5 years since the fund’s inception, and how the investment opportunities have equally grown. He gives his opinion on the impact of the recent windfall tax in the UK and, mindful of the National Grid’s warnings about challenging times ahead, comments on energy storage solutions, as well as alternative power sources such as nuclear, hydroelectricity, biomass and geothermal.

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The VT Gravis Clean Energy Income fund taps into the expertise of the Gravis group to create a portfolio of renewable energy and energy-efficiency related projects, that are benefiting from the secular move to more sustainable energy demands. It looks to generate an attractive income, alongside modest capital growth, from a spread of different projects that should deliver defensive, uncorrelated performance.

What’s covered in this episode:

  • The growth of renewables in the last 5 years
  • The adjustments the industry has made with the recent windfall tax in mind
  • The investment potential in the growth of energy storage solutions
  • Investment in energy storage closed-end investment companies
  • Nuclear energy and responsible investment
  • Different renewable options overseas
  • The simple theory behind producing and storing hydroelectricity
  • The development of biomass and geothermal technologies

TRANSCRIPT: EPISODE 227
Published 1 December 2022 (pre-recorded 28 November 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

 

Darius McDermott (DM):

I’m Darius McDermott from FundCalibre, and this is the Investing on the Go podcast. Today I’m delighted to be joined by Will Argent, manager of the [VT] Gravis Clean Energy Income fund. Will, good morning, how are you?

 

Will Argent (WA):

Morning Darius. Yeah, very well, thank you.

 

DM: Excellent. So, let’s get straight to it. The fund is coming up to its fifth anniversary. Can you tell us a little bit about how the clean energy space has evolved over that five-year period, please?

WA: Yeah, sure. Five years, [it’s] quite incredible really. Over that time, we’ve seen a remarkable rise in sustainability and net zero ambitions, both governmental and on the corporate side as well. And these targets are driving significant growth across the sector. You’ve seen supply chains rationalised – except [for] the impact of the pandemic – costs have reduced, jobs have been driven through this energy transition; new installed renewable capacity has grown and its influence on the grid.

For us, the investable opportunity set has of course expanded, not just in our area of focus which is of course the physical infrastructure side of things, but also in more pioneering areas in clean tech, for example, and applications.

I think it’s fair to say that when we launched the strategy, we saw it as providing exposure to a really attractive subset of global infrastructure with very long-term structural drivers. We used to suggest it was providing access to the energy utilities of the future and I think it’s really evolving in that way.

DM: Okay. So, look, one of the negatives around the sector has been following the Autumn Statement by the fourth chancellor in the last 12 months, where he announced the 45% windfall tax on electricity generators. What does that mean for companies and your investments in some of those infrastructure plays?

WA: Yes, it’s a very good point, Darius, and of course this is relevant for the UK generators, of course. You know, we invest on a global view. Other things are being implemented in Europe, for example, but yeah, the electricity generators’ levy – this is the UK windfall tax – it reduces upside participation in higher electricity prices. There’s a threshold of £75 per megawatt hour above which aggregate sales will be hit by this windfall tax.

But I think in terms of … from the investment point of view, I think, it needs to be considered in the context of the assumptions that are factored into company valuations already. So, in the UK we own a lot of closed-end investment companies, and their Net Asset Value is derived from a discounted cash flow model. And so that incorporates a lot of elements including power prices of course. [DM: Yep]

So, overall, I expect the impact of the levy to be relatively limited on Net Asset Values. And this is really owing to a couple of factors really.

One; the fact that these companies have made various conservative assumptions around future power prices. In fact, in anticipation of an intervention from government, some deep discounts have been applied to near-term power price expectations anyway.

And then on the other hand, you’ve got other positive adjustments that will help to offset. So, things like the outcome of inflation which is sort of coming in ahead of expectations, and a significant portion of cash flows of these UK companies will be indexed through their subsidies’ exposures. I think longer term there’s definitely a question over whether the levy could deter investment in UK renewables or whether capital may be attracted elsewhere. But I think we’ll have to wait and see.

DM: Okay. So, one of the sub-themes is energy storage. There are a handful of energy storage closed-end investment companies. Do you think we’re at this very early stage of energy storage and, you know, would greater battery supply help with blackouts that have been discussed in the news?

WA: Yes. Well, I think, [the] National Grid has certainly talked about a low margin of capacity for this coming winter. And I think just last week, there was a warning about potential interruption in supply; there was a big downturn in wind output and the cold weather [had] started to set in. So yeah, I think when it comes to energy storage, the real limitation at the moment is installed capacity, quite simply, which needs to increase substantially in the coming decade and beyond. And that’s in order to harness and smooth the intermittent output from renewable generation. So, growth in storage solutions will be focused around, I think, really two technologies or asset types, I suppose. One would be battery technology but also pumped hydro. So, water reservoirs can be a really effective storage of potential energy.

You’ve also got the potential for green hydrogen to come on, where it’s a good way to store excess renewables production in times of lots of output. But it really comes back to this need for more capacity, and [the] National Grid, they have a range of future energy scenarios that they model around under their ‘Leading the Way’ scenario, which is probably their most ambitious scenario in terms of moving towards net zero. They see requirement for around 20 gigawatts of battery storage by 2030 in the UK. I think we’re currently pushing towards two gigawatts, so you can see the type of growth that needs to come through.

DM: Yeah. So, with the energy crisis or the weaponisation of gas following [the] Russia-Ukraine conflict, another area of power generation which has come back into focus, is nuclear. I think nuclear energy is technically a clean energy. Is that something you could or would invest in, going forward? And if not, why not?

WA: Yeah, very sort of pertinent question. I think on a global view, you know, governments take a differing view. The UK is a proponent of nuclear having a significant part to play in the electricity mix.

Our fund, the VT Gravis Clean Energy Income fund, adheres to a Responsible Investment Statement which at this time precludes investment in nuclear generation assets. So, at the moment we have no exposure to operational nuclear generation assets.

I would note that, in the past, and it may well come around again in future, we have had some modest exposure to companies that are in some way involved in the nuclear industry, providing services or perhaps components, for example. But in answer [to] the question, at this time, we don’t see it as an investable opportunity for us, given the way the fund is managed.

DM: So, you’ve mentioned a couple of times the fact that this is a global product, so we’re not just constrained to UK holdings. What areas are you invested in overseas that you either can’t get access to via UK holdings, or in fact they’re better value or things like that?

WA: Well, we look at companies that are sort of typically exposed to a very broadly diversified portfolio of renewable and efficient energy generation types.

I think in the UK, for example, solar and wind really do dominate in the renewable space. But in other jurisdictions, things like hydroelectric is far more significant. You know, in parts of Scandinavia, North America, New Zealand, for example, we have quite significant exposure to hydro via our international holdings in those countries.

I think a lot of it’s down to the available natural resources, of course: the UK’s clearly well positioned to harness offshore wind, for example. And the nations I just mentioned have significant resources – geographic resources – that allow sort of hydroelectric to be a greater part of the electricity supply mix, for example. So, yes, I think by having that global view, you can get a broader exposure or a more balanced exposure if you wanted, to a range of renewable power sources.

DM: Could you tell our listeners a little bit more maybe about how hydro-electric works, I think we can understand capture of sun and wind turbines [for] capture of wind energy. How does hydro-electric work in practice?

WA: Yeah, so hydro-electric is a very old form of generating power, of course, it’s using gravity, so you’ll have reservoirs filled with water, and of course this is where you really want to have this sort of geographic environment that makes this conducive; big pools of.. big reservoirs of water that are able to be essentially discharged downstream running through a generator to power …sorry… to generate electricity.

The idea of pumped hydro is reversing; pushing that water back up hill when you’ve got abundant clean energy output, so from wind and solar, for example, to produce that power, push that water back uphill to be stored in a reservoir for discharge when required. So, that’s a really efficient way of sort of storing the potential energy as, I think I mentioned earlier. But it’s quite a simple theory, I suppose.

DM: So, look, we’ve done nuclear and that’s not involved, and we’ve done solar and we’ve done wind energy and we’ve just touched on hydro, so thank you for that. So, maybe we could just finish by talking a little bit about geothermal and biomass energy. How do they work? And again, with this being a global fund, whereabouts in the world are you able to get those sorts of assets?

WA: Yeah, I think, well biomass, we certainly have exposure in the UK, it’s very, very modest. I think biomass can tend to be limited by feed stock requirements. So, things like wood pellets that they use to power the generator.

Geothermal is a proven technology, but I think relatively nascent, in terms of scale certainly. It does have the potential to grow and become a real investment opportunity for us in the future, I think.

In fact, here at Gravis, another side of the business, we have direct experience and exposure to the sector through involvement in the geothermal project at Eden in Cornwall. So we know a bit about it. But like I say, in terms of investable opportunities at this time [it’s] fairly limited for us. But I think there’s a good chance that that changes in future.

DM: Great. Well, listen, Will thank you very much for giving us a whistle stop tour of the clean energy investment opportunities. And, for all of our listeners, if you’d like more information on the VT Gravis Clean Energy Income fund, please do visit FundCalibre.com. And please do also remember to like and subscribe to the podcast.

 

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.

 

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