We have expressed doubts about US yieldcos before. They have to keep buying assets in order to generate returns for shareholders, which carries the risk they will pay too much.
Indeed, as you have read in the news section, the head of top US yieldco NRG Yield has said this week that prices are too high.
But at least firms like NRG Yield can control how much they pay for assets. Now firms in this sector also face a risk they cannot control.
Next month, the US Federal Reserve is tipped to raise interest rates, which some analysts and economists say could be the first of two US rate rises by the end of this year. The Fed has kept interest rates at near zero since the economic crash that started in late 2008 but, with inflation picking up in the US, it has indicated that a series of gentle rises is coming.
Alas, the impact on yieldcos would be anything but gentle.
To re-cap, energy companies set up yieldcos in order to hold operational assets including wind farms. The yieldco buys the completed assets from the energy company, as well as other sources, which gives the seller more money to invest in new developments. And the benefit to investors in the yieldco is the stable returns they get from the operational assets.
Bloomberg New Energy Finance reported that, in the US and Europe, 15 yieldcos have raised $12bn in the public markets over the last 30 months; and their market values have risen 84% to $28bn over the same period.
The problem is that, when interest rates rise, it boosts the returns that investors can get from other investments such as government bonds, which means that returns from wind-focused yieldcos look less attractive. The result is it will then be tougher for these yieldcos to raise more money to make further investments; and this also means that there is less money flowing on to the energy companies that set up the yieldco in the first place.
US yieldcos are looking to grow more aggressively than their European counterparts.
Among the most aggressive are NRG Yield, which said last year that it expected to grow its dividend by between 15% and 18% over five years; SunEdison’s TerraForm Power has committed to 15% growth over three years and has been highly acquisitive; and NextEra Energy Partners is looking for growth of between 12% and 15% over the next five years.
By contrast, London-listed yieldcos The Renewables Infrastructure Group and Greencoat Wind have said they are simply seeking to increase distributions in line with inflation.
Undoubtedly, a rise in US interest rates will reduce investment in US yieldcos and curtail some of the aggressive expansion plans, but in our view that would be no bad thing.
When these yieldcos are raising large amounts of money then it puts pressure on them to spend it, which means extra pressure to buy assets and greater risk of overpaying. In the long-term that makes the model unsustainable.
When interest rates rise, that may help to remove some of this pressure, and mean that the yieldcos left behind are more stable long-term investment prospects.
Ultimately, a reputation for stability is better for the wind sector than boom and bust.
Four Republican congressmen have called for a halt to US offshore wind projects because of unsubstantiated claims blaming the industry for whale deaths. But this obvious misinformation can still be a threat for the growth of the industry.