Is it time to invest in the UK’s green transition again?

One hundred miles out to sea from the Yorkshire town of Hornsea, the world’s largest offshore wind farm is set to start operations in three years — a giant array of more than 300 turbines, their blades over 100 metres long, generating enough electricity to power 3.3mn UK homes.

The Hornsea 3 project, being developed by Denmark’s Ørsted, was among nine offshore wind farms that secured government price guarantees in an auction completed this month — a stark contrast with the previous auction a year before, in which not a single such contract was agreed.

The decision to increase financial support for offshore wind is just one part of a shift in energy policy under the new UK government that has sparked a surge of optimism among clean energy-focused fund managers.

“We think Labour have a massive mandate from the UK public in this area,” says Alex Brierley, co-head of renewables at Octopus Investments. “And that is super exciting for us investors.”

After a shortlived spell of green boosterism under Boris Johnson, Rishi Sunak’s Conservative government had emphatically cooled its public messaging on the drive for net zero emissions. In contrast, Sir Keir Starmer’s Labour party had a thick green seam running through its election manifesto, with promises to use low-carbon investment to create jobs, boost energy security and make the UK a “clean energy superpower”.

But, as the early excitement around the election subsides, Starmer’s government is now under pressure to show exactly how it plans to meet its ambitious green pledges, which include decarbonising the entire electric grid and halting the sale of new petrol-powered cars by 2030. Whether or not Labour succeeds in meeting its targets, its effort to do so is likely to create opportunities for investors, including Financial Times readers managing personal portfolios. Those who choose to invest in these areas will be hoping the new government can defy its doubters.

London’s FTSE 100 index is not filled with companies poised to enjoy outsized gains from the UK energy transition — particularly after oil majors BP and Shell both pulled back on their renewable investment plans under new leadership. But two companies in particular have their prospects tied closely to the Labour energy plans: National Grid, which operates the electric grid in England and Wales; and SSE, which does the same in northern Scotland as well as being one of the UK’s biggest electricity generators.

(The 2030 grid decarbonisation goal) is probably not going to be possible . . . But that doesn’t really matter to the investment case. What’s needed is an effort towards it

The most important goal in Labour’s energy strategy — and arguably the most ambitious target in its entire manifesto — is its pledge to make the UK electricity system carbon-neutral by 2030. That is a big reach, considering that 33 per cent of the country’s generation still came from fossil fuels last year. And electricity demand is set to rise strongly in the years ahead, driven in part by the shift to electric cars and the growth of power-hungry data centres.

All this means the government’s green goals rely heavily on the grid operators’ ability to roll out vast amounts of new infrastructure to connect a wave of new renewable power plants with commercial and residential consumers. That will require huge amounts of capital — as became clear in May, when National Grid carried out a rights issue of £7bn, the biggest such issuance in the UK since 2009.

The company’s share price plunged 11 per cent when the capital raise was announced. “It initially went down very badly with investors — they were surprised by the size and the timing,” says Peter Bisztyga, head of European utilities and renewables research and Bank of America. But the stock has since more than recovered those losses, and is now trading 11.5 per cent higher than 12 months ago, compared with a rise of 8.1 per cent for the FTSE 100 index.

SSE, too, has been performing strongly, up 20.3 per cent over the same period, as it pursues a strategy of investing up to £40bn in “low-carbon energy infrastructure” in the decade to 2032. The Scottish company’s network investment will give it “one of the fastest-growing regulated asset bases of any listed company in Europe”, Bisztyga says.

The highly regulated nature of the electricity network business can act as a constraint on these companies but it also means their shareholders can have an unusual degree of confidence their capital investments will earn a return. UK energy regulator Ofgem stipulates an allowed return on equity — in effect a guaranteed return, given their monopoly status — for electricity distribution networks, of 4.3 per cent after inflation.

The grid companies should also expect Labour to make a serious effort to reform the planning and permitting rules that have held back infrastructure investment, with some projects facing connection delays as long as 10 years, says Deepa Venkateswaran, head of utilities and clean energy research at Bernstein.

The 2030 grid decarbonisation goal “is probably not going to be possible”, Venkateswaran says. “But that doesn’t really matter to the investment case. What’s needed is an effort towards it.”

The London market may be light on clean energy behemoths but it is unusually well populated with listed investment trusts focused on the space — a structure that has become a big source of capital for green projects in the country.

The biggest of these is Greencoat UK Wind, which since 2013 has collected a portfolio of 49 wind farms that account for 7 per cent of the UK’s total wind capacity. Those assets have a total valuation of £3.6bn, according to the fund managers. Yet the investment vehicle’s market capitalisation is 11 per cent lower, at £3.2bn.

That valuation discount is relatively slim compared with other London-listed green investment trusts, which have been hit by falling share prices over the past two years.

In part, this reflects a shift in sentiment around energy investment, as oil producers have profited from higher hydrocarbon prices amid the disruption caused by Russia’s invasion of Ukraine. Renewable companies have also been hit by commodity price inflation that has pushed up the costs of their inputs. Most critical, however, has been the rise in interest rates after an extended period of exceptionally low borrowing costs. This has pushed up costs for renewable developers, and made their returns look less attractive compared with lower-risk investments.

“This is the first time that large scale renewable investing (has faced) a raise in rates,” says Matthew Ridley, co-manager of Greencoat UK Wind. But the depressed share prices of these investment trusts presents a buying opportunity, especially for income-focused investors, he argues. Greencoat UK Wind currently offers a dividend yield of 7.1 per cent.

“These investments are less volatile, less correlated to Nvidia,” he says, referring to the US chip giant that has enjoyed extraordinary share price gains in the past two years. “It’s a stable revenue profile that will increase with inflation.”

Funds such as this will benefit only indirectly from a surge in renewable development under Labour because they buy existing assets from developers rather than finance new ones, Ridley notes. Still, investor expectations of a more profitable environment could bolster expectations of the fund’s performance — a factor that may have contributed to a 9 per cent bounce in the month following the election.

Labour has made big promises for a huge increase in renewable capacity: it has pledged a doubling of capacity in onshore wind, a tripling in solar and a quadrupling in offshore wind by 2030.

The first of those has been particularly encouraging to some renewable investors, who were perturbed by what was seen as a de facto moratorium on new onshore wind turbines under the Conservatives, who required local community approval for new wind farms. Such moves meant the UK “really fell down the rankings in terms of being an attractive green energy investment location”, says Peter Bachmann, head of the sustainable infrastructure division at Gresham House, which runs a range of listed green funds. The new government dropped the onshore wind restrictions in its first week in office.

These auctions are important. The market needs to see prices that reflect a good return for these assets

A further encouraging sign for the renewables sector has come with the new government’s decision to sharply increase the budget allocated for the latest offshore wind auction, in which developers bid to build projects with power prices guaranteed by the state. Nine offshore wind contracts were awarded — a sharp contrast with last year’s auction when the previous auction failed to attract a single bid from developers who felt the price guarantee from the government had been set too low.

“These auctions are important,” says Alexander Wheeler, an analyst at RBC Capital Markets. “The market needs to see prices that reflect a good return for these assets.”

But investor sentiment in this space has only recovered so far, as shown by the continuing discounts to net asset values at which clean energy investment trusts are trading. While the book value of the trusts’ assets has declined too, in many cases, the drop in their share prices has been far larger.

This might present a buying opportunity for stock market investors but it is undermining the trusts’ role as a source of capital for the sector, warns Alex O’Cinneide, chief executive of Gore Street Capital. The firm runs an investment trust focused on large-scale battery storage, which will be needed en masse to ensure stable power from a grid reliant on intermittent renewables.

Investment trusts are generally unable to issue new equity when their shares are trading at a discount because to do so would be against the interest of existing shareholders. “One of the biggest mechanisms (through which) capital has been raised and deployed in renewables in the UK is not available right now,” O’Cinneide warns.

Still, funds such as Gore Street may stand to benefit from the government’s creation of two new investment vehicles designed to catalyse private-sector activity: Great British Energy and the National Wealth Fund, capitalised with £8.3bn and £7.3bn respectively. GB Energy will invest in a range of clean energy technologies and projects, while the NWF will focus on a handful of strategic low-carbon industries, including grid-level storage, green steel and carbon capture.

While investors are encouraged by the signal sent by the new state investment bodies, and on the lookout for benefits they may offer, their combined capitalisation amounts to “somewhat of a rounding error” against the hundreds of billions of pounds that will be needed to decarbonise the UK economy, says Bachmann at Gresham House.

Of greater concern, he adds, are the details of Labour’s promised planning and permitting reform, which could reduce the huge backlog of renewable energy projects awaiting approval. “All of us in the industry are waiting with bated breath,” Bachmann says, adding that he expects more clarity on the plans by the end of this year.

Other investment opportunities for retail investors include The Renewables Infrastructure Group, with a market capitalisation of £2.6bn, and the Octopus Renewables Infrastructure Trust, a sister business of electricity provider Octopus Energy. HydrogenOne, a listed fund that invests in hydrogen technologies from large-scale production to clean aviation, has fallen in value by 59 per cent since its 2021 flotation, but could stand to benefit from government efforts to boost the green hydrogen industry, which is another target sector for the NWF.

Some major European energy companies are also hoping to benefit from the growth of green energy in the UK — from Ørsted and fellow offshore wind giant RWE of Germany, to Spanish utility Iberdrola, the owner of Scottish Power. UK investors seeking exposure to the energy transition have plenty of other international options — whether through the plethora of listed clean tech companies from the US to China, or through global funds such as BlackRock’s $3.3bn iShares Global Clean Energy exchange-traded fund.

I wouldn’t underestimate the importance of certainty and clarity . . . in terms of giving investors and companies confidence to invest

Compared with other markets such as the US, the UK has a relative scarcity of listed entities focused on green energy — a symptom of the London stock market’s broader struggle to attract listings in recent years, says Joe McDonnell, chief investment officer of Border to Coast, the UK’s largest pool of local government pension schemes. Still, UK pension funds are finding attractive green assets in private markets. Border to Coast’s recent investments include a stake in electric vehicle charging operator Instavolt, whose prospects have received a boost from the Labour vow to ban the sale of new petrol and diesel cars from 2030.

With that goal, and with the grid decarbonisation target, Labour’s green plan is among the most ambitious in the world. Retail investors feeling more bullish about UK green assets will be in the company of big institutional investors, says Daniel Hanna, Barclays’ global head of sustainable finance. Amid policy uncertainty in much of the world, he notes, the UK stands out for having a government with a strong electoral mandate for a green agenda, and a full term ahead to implement it.

“I wouldn’t underestimate the importance of certainty and clarity around where the government wants to go, in terms of giving investors and companies confidence to invest and make long-term plans,” he says.

But a cautious eye on the political outlook seems warranted. In the year before the election, Labour found it expedient to scale back dramatically a £28bn annual green spending pledge that had been one of its most high-profile policy positions. Sections of the opposition Conservative party — as well as Nigel Farage’s nationalist Reform party — have characterised the “net zero agenda” as the expensive folly of an out-of-touch elite. They will be ready to take advantage if Labour’s planning reforms anger rural communities unhappy with the appearance of wind turbines and transmission lines.

“Political cycles are short, right?” says O’Cinneide. “This government’s got two or three years to do things right before they’re going to be thinking about the next election.”