Market developments

Climate change and the future of our planet has taken centre stage as a key concern. Average global temperatures in 2017 were almost 0.84 degree Celsius higher than the 20th century average, making 2017 one of the three warmest years since measurements started1. This temperature rise is mainly driven by increased carbon dioxide and other human-made emissions into the atmosphere. Most of the warming has occurred in the past 35 years, with 17 of the 18 warmest years on record occurring since 2001.

Public awareness has increased, with governments around the world considering stimulus measures to achieve a more sustainable mix of electricity generation and phasing out conventional sources of power generation, such as coal, in favour of renewables. Whereas in 2016 the ratification of the Paris Climate Agreement increased awareness of climate change, in 2017 the sustainable development goals added to this by providing investors with a roadmap for impact investing. Climate change is one of the most important issues addressed by the sustainable development goals. Institutional investors are becoming increasingly aware of the risks of their high exposure to fossil fuels and in addition, in the case of pension funds, exclusion policies are increasingly being replaced by policies that aim for positive impact. Investments in renewable energy are among the choices that are made to achieve this.

The attention for climate change and the ratification of the Paris Climate Agreement underline the urgency of investments in renewable energy. The share of renewable energy in the energy mix is growing throughout Europe. Proven technologies are becoming increasingly competitive relative to fossil fuel generators and governments are revisiting the support mechanisms for renewable energy production. Europe is moving towards an auction-based model, which would result in a further reduction of the costs of renewable energy, as projects would need to be competitively priced. The side effects are that government support is used more efficiently and the resulting projects are more competitive compared to fossil fuel projects.

In a maturing renewable energy sector and given the current transition to a low-carbon energy system, the fund positions itself as an experienced and reliable financial partner and supports developers of renewable energy projects. Triodos Renewables Europe Fund will continue to focus on opportunities in areas with relatively modest support programmes, demonstrating the sustainability of the projects by employing proven technologies.

Regulatory support mechanisms account for a substantial part of the revenues of the projects which the fund invests in. The fund believes that the regulatory support, for which the projects in the portfolio have already qualified, will remain stable. During 2017, long-term power price projections for European electricity prices were adjusted downwards as a result of lower gas price forecasts beyond 2020, as well as adjustments to renewable energy penetration following accelerated cost reductions and adjustments of government policies. The forecasts were incorporated in the fund’s valuation during 2017.

Wholesale electricity prices recovered in 2017, triggered by a recovery of oil and gas prices. Long-term power price forecasts were adjusted downwards throughout the year, as the continued strength of the euro resulted in lower US dollar-driven gas prices beyond 2020. In addition, a faster than anticipated reduction of capital costs for certain renewables technologies was incorporated in long-term forecasts.

Another important driver of future electricity prices is the energy transition. The transition of support schemes from fixed to auction-based has driven down the level of support provided by governments. Together with the accelerated cost reductions for several technologies, solar in particular has triggered an upward adjustment of the forecasted penetration of these technologies. This in turn has an effect on the generation base in each country and therefore on the price-setting mechanism. The adoption of battery storage as an alternative for peak production, for instance in the UK, is an example of the effect of the introduction of new EU energy market regulatory regimes. These developments will affect wholesale electricity prices in several European markets.

The renewable energy projects in the fund’s portfolio sell electricity and therefore have exposure to the wholesale market. The fund mitigates this exposure to price volatility in the wholesale electricity markets by a range of measures, including deriving revenue from regulatory support and power sales agreements incorporating fixed prices. The fund also reduces its exposure to energy prices through its geographical diversification, as each country has different power price sensitivities and support schemes for renewable energy. Projects financed by mezzanine loans are less sensitive to power price developments.

The countries where the fund has investments (see table in chapter Investments) have credit ratings varying from BBB+ to AAA. With the exception of Spain and Italy, all countries have a minimum rating of AA according to S&P ratings as per the end of 2017. The reduction of the level of support mechanisms for new projects is also in line with the objective of the fund, as this demonstrates the sustainability of these projects, with lower capital expenditure per MWh required. Especially for solar projects the continued downward trend of construction costs, mainly due to falling solar module costs, is considered a positive sign of the improved profitability of renewable energy projects, which implies a reduced dependence on government support. This will enable the fund to acquire projects at lower costs. Where applicable, government support for each project is contractually secured at the time of investment.

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