Market developments

Climate change and the future of our planet were a prominent discussion topic in 2016. Average global temperatures in 2016 were almost 1 degree Celsius higher than the mid-20th century mean. This makes 2016 the third year in a row to set a new record for global average surface temperatures. 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 16 of the 17 warmest years on record occurring since 20011.

Public debate has intensified, with governments around the world considering stimulus measures to achieve a more sustainable mix of electricity generation, phasing out conventional sources of power generation in favour of renewables. The awareness of the potential consequences of rising temperatures increased in the course of 2015-2016, with the signing and ratification of the Paris Agreement on climate change playing an important role in this respect. A common framework was introduced, requiring all countries to put forward their best efforts. For the first time, parties are required to report regularly on their CO2 emissions and implementation efforts, subject to international review.

The attention for climate change and the ratification of the Paris Agreement underline the urgency of investments in renewable energy. Renewable energy 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 in costs, as well as less government support for renewables. 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 small to medium-sized renewable energy projects.

Triodos Renewables Europe Fund will continue to focus on opportunities in areas with relatively modest support programs, demonstrating the sustainability of the projects by employing proven technologies. The declining capital costs of proven renewable energy technologies continue to improve the competitiveness of renewably generated power. The fund therefore sees justification in reducing the dependence on regulatory support mechanisms in the sector and thus for increasing the sustainability of the energy system.

Regulatory support mechanisms account for a substantial part of the fund’s revenues. The fund believes that the regulatory support, for which the projects in the portfolio have already qualified, will remain stable in the next 20 years. During 2016, we saw a reduction in the long-term projection of European electricity prices. This was driven by the drop in global oil prices and a proposed regulatory change in many European countries. Later in the year the price forecast recovered, fuelled by higher expected coal prices in the long term and a stronger US dollar. Both these changes have been incorporated in the long-term price projections that are used to calculate the fund’s value.

Approximately half of Europe’s electricity is generated from oil, natural gas or coal, the costs of which are all closely correlated to global oil prices. Wholesale electricity prices significantly declined in 2016, due to a decrease in oil and gas prices. As gas plants are likely to take a more dominant share in the overall production mix and oil prices remain relatively low, we may expect further (downward) pressure on European electricity prices going forward.

The second driver of future electricity prices is the introduction of new EU energy market regulatory regimes. These new regimes will affect wholesale electricity prices in several European markets. The so-called capacity market mechanisms will provide supplemental income for fossil-fuelled power producers to ensure security of supply. This supplemental income will allow them to bid into the wholesale market at a lower level, thus reducing the prices in the wholesale market. The capacity market mechanisms are part of a package of measures aimed at supporting the continued proliferation of renewable energy projects.

The renewable energy projects in the fund’s portfolio sell electricity and therefore have exposure to the wholesale market. The fund mitigates its 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. As a result, changes in the long-term energy price outlook only had a limited impact on the portfolio’s value.

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. Following the outcome of the Brexit referendum in June 2016, the UK is expected to remain closely integrated with the EU, converging on a European Economic Area (EEA)-type of arrangement in the long-run, with a relatively short period of uncertainty while these new arrangements are established. At year-end 2016, the United Kingdom had an AA rating. The reduction in 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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