How wind farms can power pension returns

Wind turbines as tall as the Eiffel Tower, with blade tips that move faster than Lewis Hamilton on the straight at Silverstone. Offshore and out of sight, each revolution of a single turbine will generate more than enough electricity to supply the average British house for a day.

This exciting new generation of wind turbines is coming soon to UK shores, after the government this month agreed on pricing for them. They are engineering masterpieces that can help power us all to net zero.

They also generate cheap electricity.

At a time when UK households are in the midst of a cost of living crisis and facing soaring energy bills, the wind farms that are going to come online in 2026-2028 will generate and sell their electricity at around £45-50/MWh. This is one-fifth of the price of electricity today. And they are good for the planet with their zero carbon electricity generation at huge scale irrespective of the availability and price of fossil gas. 

Clearly, wind turbines are great for consumers and the environment, but it might surprise you to find out that they can also make great investments for pension fund investors. One industry leader even recently described them as “the perfect asset” for defined benefit (DB) pension schemes.

Here are four of the reasons why.

1. A very reliable machine

These turbines are usually available to generate more than 95-97% of the time. They generally require fewer than 20 days a year for regular servicing and maintenance, which can often be scheduled for less windy periods.  Manufacturers are so confident of this reliability that they usually guarantee this level of ”availability” over the first 15 years of a turbine’s life. And even beyond that, the performance remains excellent, with the expected level of availability only falling by a few percent over the remaining operating life.

Wind farms being built today utilising state of the art technology and materials are expected to perform even better for even longer.

Given that nearly a third of Schroders Greencoat’s employees are engineers with years of overseeing renewable energy plants like this, we feel confident about this expectation being met.

2. Predictable generation volumes

At the height that modern wind turbines stand, and how far they are off-shore, the amount of wind is plentiful. It is also highly predictable. The technology and expertise around the measurement and prediction of the amount of wind in a certain area has improved as the industry has grown, and is today a science, rather than the art it was when the industry first started.  This means that when we use our engineering expertise to derive a forecast, we can be very confident in its accuracy.

These two factors combine to make the prediction of electricity generated over the long run incredibly reliable.  Yes, there will be more or less windy years, but over 30 years the mean volume of electricity generated will most likely be within 2% of the forecast at construction.

3. Price stability and inflation linkage lead to predictable revenue

These wind farms will sell the electricity they produce under a contract that is structured in an attractive way for pension funds.  The contract is called a Contract for Difference (CfD).  It is a fabulous contract.  It allows wind farms (and other renewable energy assets) effectively to sell their electricity at a fixed price for 15 years, with that fixed price being guaranteed by a UK government-backed entity.  The fixed price inflates every year in line with CPI. This provides tremendous price certainty to the projects as well as an attractive inflation linkage. We then use forecasts provided by top energy price forecasters to predict the price at which the electricity will be sold on the market after the CfD has expired.

Taken together, these three factors mean that the project can be expected to have an extremely predictable inflation linked revenue stream for the first 15 years of its life and then be exposed to the price of electricity only in the back years of its life.

4. Certainty of operational costs leads to predictable income

The costs for offshore wind farms are highly predictable with most of the cost coming from the index-linked contracts used to pay for turbine maintenance, rent and the cost of connection to the mainland.  These costs are very low (c25-40%) compared to the overall revenue generated by the wind turbine.

Taken together these four factors provide investors with a very predictable “secure income” and inflation-linked cash flow.  This type of return profile marries beautifully with the liability cash flows that defined benefit pension schemes will be required to deliver for decades to come. 

The profile of the investment return

Our focus is on this secure income, and we assume that a wind turbine will be worth nothing at the end of its 30-year life. This means all the return comes from the quite predictable cashflow, and not how much we can sell our winds farms for at some stage in the future. This reduces the volatility of the investment and also makes it more consistent with DB liabilities.

Further, when we value our assets we ascribe our more certain and earlier cashflows more value than those cashflows that are less certain and further away.    

For wind farms like those that have been awarded the recent CfD, that means that 65% or more of the value comes from the cashflows expected in the first 15 years (which is only half its expected life). 

Lastly, energy security has become a feature of political discourse over recent weeks and months and its effects and impact are only becoming more heightened. The war in Ukraine is resulting in talk of rationing of gas in Germany this winter. Average household bills in the UK have risen from £1,200 a year ago to £3,200 forecast for this winter. Energy from wind turbines located in UK waters can supply cheap, secure, low carbon electricity for years to come. It just needs to be built and financed. 

Schroders Greencoat-managed funds already provide around 8% of the capital invested in UK renewables: wind, solar and biomass. While we have focused on wind here, we think each of these different types of renewables has some amazing characteristics that investors should value.

So, what’s not to like for pension funds investing in the energy transformation?

• Investment in renewables is an opportunity to become a key contributor to the energy transition, while exploiting an attractive investment opportunity
• Investing in wind turbines (and other forms of renewable energy) gives investors their capital back through a regular, predictable and high income over the lifetime of the asset. For this reason it is falls within the definition of secure income investing.
• The high level of turbine availability and consistent wind means that the amount of electricity generated is relatively easier to forecast, while the way wind turbines sell their electricity (CfD provides 15 years of price certainty, linked to inflation) means overall revenue is predictable.
• Investors are expected to receive returns well above gilts, providing excellent “matching plus” type of investments, with inflation linkage and no collateral posting obligations
• By financing the energy transition and mitigating the effects of climate change, pensions and their pensioners are creating a better world for themselves in their retirement and for their grandchildren, while also helping to ensure energy security.