“Go nuclear and go large and go with Sizewell C”, the final words from Boris Johnson as prime minister, before he hands over the office to possibly Rishi Sunak or, more likely, Liz Truss, next week. It is not surprising that Johnson, known for his love of grandstanding while being simultaneously sketchy on the details, has touched on the topic of energy, which is most peoples’ biggest concern right now, as he wraps up to leave office. Energy costs, which were rising prior to the invasion of Ukraine have ballooned since, affecting the cost of most other things. In turn, this has contributed to a cost of living squeeze, the like of which we have not seen since the 1970s.
In addition to some advice for the next PM, Johnson included some good news – the government has pledged to put £700m into the deal to get the project going – just part of the £1.7bn of Government funding that is being made available for developing a large-scale nuclear project to final investment stage in the current parliament. While it may sound a lot, it is not. It has been estimated that the Sizewell C project, which is being developed by the French multinational energy company, EDF, will cost some £20bn overall and such projects have a tendency to arrive both late and over-budget. That’s quite a gap and will take some time to deliver – even if an agreement can be struck, Sizewell C is not expected to start generating electricity until the 2030s.
Renewables popular as energy costs soar
It’s perhaps not surprising that renewables and the battery storage that is highly complementary to this, are proving to be popular today. The average premium across the UK focused renewables and battery storage funds was 8.2% at the time of writing and, anecdotally, enquiries for domestic solar panel installations have reportedly taken off.
The renewable generators have also been posting strong NAV uplifts as a result of the effects of both higher inflation (many funds benefit from subsidies that are explicitly linked to inflation) and higher energy prices generally. For example, JLEN Environmental Assets, which is the most diversified of the renewable funds, but benefits from a particularly high level of subsidy income versus its peers, saw its NAV increase by 22.2% during the first half of this year.
Bluefield Solar, which has been predominantly a UK solar fund but has recently been adding wind to its portfolio, saw its NAV increase by 13.9%, which followed on from healthy increases at the back end of last year too. NextEnergy Solar saw its NAV grow by 16.6% in the first half and similar uplifts are being seen across the sector. In addition to this welcome capital growth, these are income funds and investors continue to benefit from healthy yields – typically between 4.5% and 6% of the share price, with quarterly distributions.
A fine line to walk
There were some concerns earlier in the year that the generators could be hit with a windfall tax, which gave the renewables a wobble. In the end, the government decided against applying this to renewable operators, most likely because the administration understands that we continue to need a colossal amount of investment in renewable energy infrastructure, and taxing them heavily creates a big incentive to not invest. However, with winter approaching and prices continuing to rise, we may yet follow the calls coming from Europe to decouple electricity from gas prices (the price of gas tends to set the marginal cost of electricity as the grid is reliant on gas peaking plant to balance power demands).
The government has a fine line to walk but I expect it will be sensible as it will not wish to discourage private funding. Energy security concerns have been talked about for some time and successive governments have failed to address the issue properly. However, the UK has managed to wean itself off of coal during the last ten years (aided by the significant investment in renewables of which the London-listed closed end renewables funds have played their part) and, when the invasion happened, we were far less dependent on Russian gas than our European neighbours, but we were of course affected as oil and gas are international markets.
More baseload required
Fundamentally, we need more baseload supply and renewables, which are inherently intermittent in nature, are ill-suited to supply this. Battery technology, while improving, still has some way to go. This brings us back to nuclear, which is a stable, baseload, source of energy that is non-carbon emitting. We need a mix of supply sources and nuclear needs to be a greater component of the mix. Investors can get exposure to nuclear by owning some of the larger utilities or possibly through utilities and infrastructure funds (trusts such as Ecofin Global Utilities and Infrastructure spring to mind, although you will also gain significant exposure to renewables and other infrastructure through this fund and it is therefore best suited to investors seeking a broad exposure), or by owning one of the uranium funds.
Uranium market is tight
Even prior to the recent rises in oil and gas prices, and the escalation of the conflict between Russia and Ukraine, the supply-demand dynamics of the uranium market looked set to favour producers for some time. However, the space has benefitted over the last month as news that Japan has, in the face of tight energy markets, announced plans to re-start more of its reactors, which were shut following the Fukushima Daiichi disaster in 2011. Of the 54 nuclear reactors in Japan, 42 are operable reactors but only 10 reactors in 5 power plants had actually been restarted, while a total of 24 reactors had been scheduled for decommissioning or were in the process of being decommissioned.
Japan, which appeared to be out of the nuclear equation, now looks to be a growing source of demand and this was before Johnson made the case for more UK plants such as Sizewell C. Looking at energy needs, growing demand for uranium is expected from both developed and developing markets (China has developed a cookie cutter approach to building reactors), yet years of poor pricing and under-investment has seen uranium supply leave the market. Given the significant costs of constructing and maintaining a nuclear plant, the cost of uranium is a relatively small part of the overall cost of nuclear energy. This means that demand tends to be price-inelastic, at least in the short to medium term, offering the potential for considerable upside in the uranium price.
With nuclear firmly back on the agenda for many western European governments, the story could have many years to run and funds such as Yellow Cake and Geiger Counter offer exposure to this market, which can otherwise be difficult to access. Yellow Cake is an ETF which holds physical uranium and so its performance is highly correlated to the uranium price, while Geiger Counter invests in the uranium miners and so tends to be a more leveraged play (it has tended to outperform Yellow Cake by a good margin).
Structural growth in markets that are short on supply
Interestingly, the uranium funds and the renewables funds are supporting different solutions to the same problems, yet their return profiles are surprisingly different. With the renewables funds, there is the potential for decent NAV growth and, in the meantime, you’re getting good income that is predictable. With uranium, while it may change in the future, this is currently a capital growth story and the returns, which could be very high, are likely to be lumpy. Investors choices may well come down to their needs, but there is a good case for holding both – they’re supported by long-term structural growth trends from markets that are currently short on supply.